Most people I ask say something like ‘Generating big returns by taking lots of risk’ and I must confess that before I joined the hedge fund industry, I would probably have given a similar answer.
But the truth is that a hedge fund is just the vehicle and, like any other type of fund structure, the return objectives and risk profiles of different hedge funds vary markedly.
Understanding the hedge fund objective is crucial. They can range from beating a cash return with minimal variation to attempting to generate significant returns. However, many investors overlook this, and the fund they choose often doesn’t match their personal financial goals.
While this mismatch of objectives is not specific to hedge funds, it might be more prevalent within our small niche of the market because many people see all hedge funds as being part of an ‘asset class’, like equities, property or bonds, rather than what they are – vehicles that can be used to invest in those other asset classes but which have a broader set of tools that can help mitigate downside risks and reduce correlation.
We like the broader toolkit that hedge funds offer us as fund managers because we find them helpful in generating better risk-adjusted returns. However, the return and risk profiles of our funds still need to be aligned with the objectives of our clients resulting in them being long-term happy investors with us.
Peregrine Capital is a focused fund manager. The upside is that we have a decent shot at being very good at what we do. The downside is that we cannot be all things to all people.
There are investors whose objectives will fit very well with ours, and others whose objectives will not.
This is a very important element of the process because mismatched expectations result in everyone being let down. As an investor, you want the funds to perform in a manner that complements your financial objectives. You will only remain invested in those funds that meet those expectations, and as a fund manager, we want the right clients investing with us for the long run. So, it’s in everyone’s interest to ensure we’re a good match.
The client willing to endure the bumpy ride on the way to a potential outsized return will not see value in a low-risk, market-neutral fund like Peregrine Capital’s Pure Hedge H4 QI hedge fund designed to deliver very stable and consistent returns. Being invested in a fund that has never had a negative return year in the past 25 years* probably isn’t valuable to them, whereas it might be very appealing to a risk-averse investor who is looking to protect their capital and grow it at a healthy rate above inflation but wants to do it in a manner that gives them the smoothest ride possible.
Conversely, many investors might be horrified to endure the large swings in performance that might come with a highly concentrated equity fund that is seeking to generate those big return outcomes but must accept the inevitable volatility that will come with such a style. Other investors might be more than happy to accept these risks in pursuing actual market-beating returns.
But how does one best assess the compatibility of a fund with your own personal objectives?
The first step would be to consider the fund’s stated objectives for the returns it’s looking to generate and the risk it’s willing to take to get those returns.
The second is to see if it has achieved those goals in the past. Ideally one would like to see this achieved over a long period of time, through various market cycles. The risk of a shorter-term track record might have been overly influenced by factors outside of the fund manager’s control (like a buoyant overall market, exceptionally low interest rates, or just a bit of good old-fashioned luck). These things play a hand in all short-term return outcomes for all fund managers, but they tend to be less and less of a driving force the longer the measurement period becomes.
The final piece of the puzzle is to assess your options for investment relative to the risks the fund manager will take.
One wants to be able to compare apples with apples, and in this case that means comparing the risk-adjusted return potential for each fund under consideration. By doing this, one can get a sense of what return outcomes can look like at various levels of risk, and thereby find the best possible fit for one’s own appetite for risk and reward.
Investing in your future is not a one-size-fits-all approach. It’s about finding the right fit for your financial goals and risk tolerance. This initial effort in choosing the right investment option is time and effort well spent.
Please consult your financial advisor to determine whether hedge funds are suitable for your financial goals.
* Refers to the Peregrine Capital Pure Hedge H4 QI Hedge Fund. Pure Hedge Fund annualised return: 18.93% | SA Multi Asset – Low Equity Category annualised return: 9.67% | CPI annualised return: 5.58%, all since inception (July 1998). Date to 30 April 2024 | Source: Peregrine Capital, Morningstar, Bloomberg.
Alan Yates is head of distribution at Peregrine Capital
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