Seeking broader diversification using
hedge funds

Creating a truly efficient portfolio relies on bringing together investments that respond to market events differently. Many investors look to the unique attributes of hedge funds as a means to diversify their portfolios.

 



Boost diversification with a
multi-style approach

The term “hedge fund” designates widely different markets, strategies and tactics. A single strategy hedge fund can provide investors with one way of hedging risk and pursuing opportunity. Like any investment, there are favorable and unfavorable conditions for an underlying hedge fund style and as the chart below reveals, there can be substantial disparity in performance year-to-year.

Performance is cyclical – Why a diversified approach has the potential to lower overall risk

Yearly total returns of selected hedge fund styles

Chart: Yearly total returns

By allocating to various hedge fund styles, investors increase the likelihood of capturing top-performing categories, reducing the impact of poor performers and lowering the volatility in their hedge fund portfolio.

Note however that investing in hedge funds is speculative and typically entails additional risks and considerations, including the use of leverage, liquidity restrictions, lack of pricing information, complex tax structures and delays in reporting tax information, high fees and less regulation than mutual funds.

Considering an allocation to
hedge funds

As part of a diversified portfolio, hedge funds seek to offer investors who meet the investment requirements and understand the unique risks the potential for better risk-adjusted returns and the opportunity for broader diversification.

By using indexes to represent various investments, the chart below illustrates that, historically, a diversified portfolio of hedge funds has exhibited attractive performance characteristics compared with stocks and bonds. It is important to remember that the performance of these indexes does not reflect the actual performance of any specific investment. Also, diversification does not ensure a profit and cannot protect against losses in falling markets.

Hedge funds can help increase return potential and
lower portfolio volatility

Hypothetical return/risk of a 60/40 portfolio compared to a diversified portfolio of hedge funds (2002-2016)

Comparison of hypothetical return/risk