Hedge funds’ “image problem” and reputation for being overly complex has left them overlooked as a diversification tool, to investors’ detriment.
Hedge funds have a reputation for being complex, high-risk and labor-intensive, but can offer uncommon and sought-after characteristics for a portfolio and improve returns, according to Mercer strategists.
They said that across Mercer’s manager research, portfolio construction and implementation, it is seeking strategies that, held together, can collectively deliver absolute returns equivalent to cash plus 4%.
Diversifying hedge fund programs by return sources and implementation styles is crucial to achieving consistent, high-quality returns, they said, and diversification is not limited to just assets.
They also advocated for a “starting at the end” approach to investing in hedge funds by selecting a manager first and using the manager as a starting point for an allocation.
They said: “By carefully weaving together managers with diverse characteristics within and across hedge fund strategies, investors can build a portfolio that is not just diversified, but strategically positioned to capture a wider range of opportunities and mitigate potential risks.”
While manager selection is the most important aspect of hedge fund investing, portfolio construction also has significant implications for returns, according to the strategists.
They also highlighted that Mercer prioritizes broad investment mandates and opportunistic management styles over narrowly focused strategies, using multi-strategy and event-driven managers, along with credit managers employing a bi-directional approach.
A dedicated hedge fund allocation can be implemented independently from the wider portfolio and can therefore be adapted to protect and drive performance.