FT-AIR Insights: Our Approach to Hedge Fund Investing

Our approach to hedge fund investing is two-fold: first, to create a well-balanced and diversified portfolio with exposure to multiple different asset classes and strategy groups and second, to select managers and allocate capital through a process underpinned by bottom-up, fundamental diligence. We view these two dynamics as the key tenets to creating lasting hedge fund portfolios that have the best likelihood of achieving investment objectives over the long term and through market cycles. In our view, one of the key positives of this approach is providing an adequate breadth of exposure to unique strategy groups to best capture the wide performance dispersion that is often observed across the hedge fund market. That performance dispersion is primarily driven by the idiosyncratic risk/return factors that managers in specific strategy groups look to capture as certain market environments tend to create more attractive opportunity sets for particular sub-sets of strategies. For instance, a market environment with high single-stock dispersion but low credit volatility should naturally lend itself to stronger performance for equity-centric strategies and a more challenging environment for long/short credit strategies. As shown by the chart below, we view maintaining stable allocations to high quality managers across each strategy group as the most efficient and cost-effective way to ensure any hedge fund portfolio remains well positioned to capitalize on periods of strong performance within each of those groups.

This approach to hedge fund investing is further reinforced by our view of how hedge funds are most effectively utilized within an asset allocation portfolio. The use-case for hedge funds in portfolios can range drastically in terms of risk and return expectations, with some allocators looking towards hedge funds as way to outperform traditional equity and credit markets, while other allocators invest in hedge funds as a way to access top-tier investor talent. We have always viewed the purpose of hedge funds within a portfolio to be, first and foremost, a diversifier – providing attractive risk-adjusted returns and strong correlation benefits when held alongside other traditional and alternative asset classes. This view is, in part, rooted in the belief that the best way to compound returns and wealth creation is through creating a well-balanced and diversified portfolio to minimize drawdowns and negative performance over time, and we view hedge funds as an integral part of any portfolio following that mandate.