Hedge funds: haters gonna hate

Much in recent press arguing against hedge funds.  Probably related to news of another large pension fund divesting completely.  Plenty of vitriol around; a good summary of why not to invest in HFs from Barry Ritholtz is here, which further sources material from FT regarding ‘zombie funds’.

Let me highlight a couple reasons I’m still happy to invest in hedge funds:

  1. Problem with averages + performance persistence = opportunities.  I recently wrote about how alternative asset managers (including HFs) show much more persistence in returns, unlike conventional asset managers.  Thus, as often thrown in as a throwaway comment in the articles above, there are managers out there which consistently beat the averages to provide attractive returns.  Unlike picking the best-performing long-only equity manager, hedge fund managers tend to show more consistent outperformance.
  2. Risk premium diversification, at needed risk level.  Though most articles focus on how not diversifying hedge funds are as a group (probably because HF indices tend to have a massive overweight towards Long/Short equity and credit, which have high correlations to long-only equity), there remain several investment strategies which provide true diversification (e.g. managed futures/CTA).  Though some of these diversifying strategies are available in more conventional form – e.g. through an ETF or mutual fund – I appreciate the additional capital efficiency provided by higher-risk versions in ‘proper’ hedge funds.  More of a barbell approach to alternative investments (an aside – here is a new paper by Nassim Taleb et al. regarding mathematical justification for a barbell approach).

In sum: hedge funds can be massive wastes of fees, particularly if their performance starts to look very much like long-only equity.  However, even a small bit of due diligence can yield solid managers with solid track records in solid diversifying strategies.

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