The key to hedge fund success

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Hedge funds seem intimidating to many people because of stories about one or more hedge funds that have failed and lost money for investors.

However, Mercer Global Alternatives chief investment officer Bill Muysken says that advisers and investors need to think about hedge funds similar to the way they think about equities.

“If you think about why people invest in equities even though some of these things have gone bankrupt, the simple answer is because they diversify. An equities investor wouldn’t think of putting all their equity allocations in less than 10 stocks,” says Muysken.

He says that advisers and investors need to think about hedge funds the same way. He suggests a minimum of 10 hedge funds per portfolio, but preferably 20-30.

Muysken says that the nature of the financial planning market is changing when it comes to investments.

“Financial planning firms are getting a lot more worried about what you might label as ‘maverick risk’…They’re getting a lot more worried about the liability consequences of recommending something to a client that ends up going belly-up.

“So the focus has shifted from focusing on peaking winners and speculative investments to putting in place sound risk management and this really plays to that.”

The reason people typically don’t use multiple hedge funds is because they’re used to using one fund manager when it comes do equities and bonds, says Muysken.

“When it comes to hedge funds there’s a supposition that all you need to do is find one fund manager to do it for you,” he said. If that manager is an individual hedge fund manager, you’re exposed to a lot of risk that is specific to the way that individual manager does things – a lot more so than with equities and bonds, where the main risk is market risk.

To invest in multiple hedge funds means selecting and monitoring a number of fund managers, which can be too complex for some.

Mercer advises many financial planners, and says that if you’re thinking of allocating a portion of clients’ money to hedge funds you can do it in one of two ways:

  1. Come up with a model portfolio. Include at least 10 hedge funds, a diversified mix of hedge funds, and preferably 20-30 if you can. Use that approach as a template of what you’ll do for clients
  2. If that’s practically too difficult the other option is to delegate it to someone who’ll put the portfolio together for you – like Mercer