Why Diversification?
A preconceived view of alternative investments and hedge funds in particular, suggests they are risky, speculative, leveraged investment vehicles. This image has been supported by the financial media which, until very recently, was poorly informed on the subject. Some of these funds were partly to blame given their previous lack of transparency, which has since improved substantially given the willingness of managers to take a more institutional approach towards investments and client relations. While some funds are indeed risky, the vast majority target a risk profile that is lower than traditional long-only equity investments.
Hedge Funds are a breed of money-manager, represented by a collection of strategies with some common features, the most important being the emphasis on absolute, rather than relative, returns.
Advantages Over Other Investments
- Access to some of the best talent in the investment world
- Emphasis on capital preservation
- Uncorrelated returns
- Reduced volatility
- Alignment of interests
- Access to new investment opportunities
As most hedge fund managers have a substantial portion of their personal net worth invested in their own funds, it ensures that their interests are directly aligned with those of their investors. Managers therefore give high priority to capital preservation, especially in times of uncertainty.
As you will see from the chart below, as an asset class hedge funds have produced attractive returns over the past ten years:
Historical Hedge Fund Returns (16Kb)
Who Invests in hedge Funds?
Some of the most conservative and sophisticated investors invest in hedge funds. In recent years the number of institutional investors with hedge funds investments has risen dramatically. University foundations and endowments are among the most aggressive institutional investors in the hedge fund arena. It is common knowledge that the leading US 'Ivy League' schools such as Harvard and Princeton have made significant allocations to hedge funds. On the corporate side, large conservative multinational firms such as IBM and RJR Reynolds have been investing in hedge funds for years. Likewise, pension funds are increasingly investing in hedge funds as a means to preserve wealth by generating constant returns while reducing risk.
Hedge Funds have historically outperformed mutual funds in a range of market conditions. The academic literature supports the notion that hedge funds offer more attractive risk-adjusted returns than mutual funds. McCarthy and Spurgin (1998), for example, found that over the time period analysed (1990-1997), hedge funds offered risk-adjusted returns greater than traditional stock and bond investments.
Recent findings have proven that mutual funds tend to under perform relative to their benchmarks. In the 1970s, about 47% of long only equity fund managers outperformed the S&P 500 and in the 1980s this figure reduced to only 37%.
Mutual funds are measured on relative performance. Their performance is compared to a relevant benchmark index or to comparable peer mutual funds in their style group. Most hedge funds focus on absolute returns. Hedge funds involved in arbitrage attempt to make profits under all circumstances, even when markets fall.
The correlation of hedge funds with equities remains low, even when markets tumble. When the S&P falls, or is flat during a quarter, the average mutual funds fall as well. The sum of the negative quarters in the 1990s was -43.8% in the case of mutual funds, compared with -0.2% for the average hedge fund.*
* Data taken from UBS Warburg's report on Hedge Funds (In search of Alpha, October 2000)
The main reason why traditional funds perform worse in downside markets is that usually, according to their mandate, they must have a certain weight in equities. In falling market conditions they are often compared to a car without brakes - traditional money managers have a limited freedom of operation contrasted with the more flexible approach that can be adopted by hedge fund managers. This is just one reason why hedge funds may do better in bear markets. Another reason is the fact that hedge fund managers have a large portion of their personal wealth at risk in their funds, i.e. they are fully aligned with their investors. This increases the incentive to preserve wealth.
Below is a slide which gives some detail as to who is currently investing in hedge funds and an example of the current asset allocation of a typical Private Client Portfolio:
Who Invests in Hedge Funds (33Kb)
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Recommended Funds
Our objective is to provide a valuable alternative investment proposition to traditional asset classes. We focus on funds that can provide investors with diversified and uncorrelated returns in order to protect investor capital in bear markets and reduce overall portfolio volatility.
A Range of Recommendations
We have selected a suite of funds and funds of funds allowing investors to select those best suited to their portfolios:
- Focus on funds offering asymmetric and/or uncorrelated returns
- Range of strategies that can help mitigate portfolio volatility without compromising returns
- Funds with UCITS III status giving tight regulation and risk management requirements
- Closed-ended and exchange traded funds
Tax, Liquidity & Transparency
Campion Capital aims, whenever possible, to provide investors with funds that offer tax advantages (where taxation is to capital gains), best liquidity terms and full transparency. We also ensure that funds provide investors with monthly reports, access to websites and that managers are available to meet investors when required.
Contact Us
Campion Capital Ltd
29 Beaumont Street
Oxford
OX1 2NP
United Kingdom
FSA Registered (No 230196)
Telephone
+44 (0) 1865 355 522
Fax
+44 (0) 870 762 0390
London Office
Campion Capital Ltd
15 Upper Grosvenor Street
London
W1K 7PJ
Telephone
+44 (0) 20 7317 4433