Institutional investors are increasingly turning to hedge fund strategies in response to low bond yields and high-priced equity markets. Some investors are building hedge fund allocations for the first time, while a second group is refining and improving existing hedge fund allocations, according to international independent investment consultancy bfinance in a recent report.
The research firm notes that hedge fund portfolio construction has changed against a backdrop of increased uncertainty, given the pandemic and its macroeconomic consequences.
“Institutional investor sentiment towards hedge funds appears to be noticeably more positive in 2021, supported by double-digit average gains in 2019 and 2020 - a level not seen since 2010”, wrote author Toby Goodworth (pictured). According to bfinance’s head of liquid markets, there are a number of shifts in this market, of which he cites “fewer mandates”, “more tools in the toolbox” and a “broader approach to diversification” as key developments.
On the subject of mandates, he wrote that before the global financial crisis, there was still over-diversification, with portfolios containing 50 or more hedge fund managers. “Now we often see well-diversified portfolios with no more than ten to twenty managers. A trend that has also supported the demand for investment approaches composed of multiple strategies and styles, rather than a limited number of styles.”
More tools
By “more tools in the toolbox”, Goodworth said he meant that in addition to hedge funds, investors now have access to Alternative Risk Premia strategies and Absolute Return Multi Asset strategies, which use non-traditional techniques. For example, Alternative Risk Premia strategies take long/short positions in different asset classes, hoping to capture returns from factors such as value and momentum.
Diversification approach
Meanwhile, according to the author, investors are increasingly seeking a balance between different objectives, something Goodworth characterises as a broader approach to diversification. In doing so, he says, many investors are focusing less on improving risk-adjusted returns (Sharpe ratio) and more on tail risk-adjusted performance, convexity during market crises and the ability to perform during abnormal market conditions.
Bfinance concluded that investors can consider allocations to market-independent and convex strategies. “While portfolio design depends on the investor’s existing exposures and objectives, these two complementary groups can work together to provide a more robust profile that is more ‘downside sensitive’.”