• Alternative Investments

Hedge Fund Strategies May Provide Diversification in a Hot Equity Market

As the summer begins to wrap up, we see the S&P setting new highs nearly every other day.  Accordingly, we see investor interest in hedge funds on the rise.  Hedge funds have been out of favor since the Global Financial Crisis, and investors’ frustration with performance, lock-ups, and fees have been the key reasons for the lack of interest.

Recent sentiment, however, has changed and the need to have a more defensive posture has wealth advisors looking to hedged strategies.  Most of the interest seems to be for equity hedged strategies, but any fund with an established track record of solid performance has investors intrigued.  Coming out of the pandemic, hedge funds posted much stronger returns over the last year and have been more competitive with the S&P 500 over more recent periods¹ as seen in the chart below.

While the S&P 500 has continued to outperform, hedge funds have posted returns much closer to that benchmark while taking on less risk overall.  With this backdrop, equity strategies remain the most popular queried search within Preqin.  As seen in the chart below from Preqin, over 63% of new fund searches were equity-related and macro and multi-strategy followed behind.  Allocators also seem to be more focused on global managers to provide even more diversification, especially as the S&P 500 continues to climb to a PE ratio of over 22%².

Another interesting takeaway from this chart is the relative lack of appetite for niche strategies such as crypto.  Searches for niche strategies only accounted for 5% of Preqin’s total hedge fund searches. This is despite the strong performance of crypto assets entering Q2.

Across our platform, PPB has seen a similar dynamic playing out with regards to the types of inquiries wealth advisors are looking to allocate to for their clients.  Global equity strategies, especially with a growth focus are drawing more interest.  In addition, investing with managers that provide more liquidity is always a wealth advisor’s preference.

The other area of past frustration with hedge funds has been broader performance compared to the fees they charge.  Partnering with the right fund managers, where investors’ interest is properly aligned is key in that regard.  PPB has seen both sides of this issue with some of the larger managers commanding 2% management fees and not delivering competitive returns.  This can create a scenario where investors feel the managers’ interests were not in alignment with their own, as they were paid massive fees on their AUM without delivering performance.  Conversely, PPB is working more now with hedge funds that charge little to no management fees. They will only make money from their carried interest if they generate positive returns for investors.

Hedge funds are certainly generating more interest this year, after providing excellent returns following the initial pandemic sell off.  With the S&P 500 reaching record highs, we believe it is prudent to include a hedged solution within client portfolios.  Allocating to the right hedge funds, where managers are not just asset gatherers, is key and helps ensure an alignment of interest.  Funds with a global mandate and a sizable equity allocation are drawing attention from PPB’s wealth advisors for their diversification benefits in what could be an overheated equity market.

For more information on PPB’s fund platform, please contact Frank Burke, CFA, CAIA, Chief Investment Officer, PPB Capital Partners, 484.278.4017 Ext. 108 or at fab@ppbadvisors.com.

Download: PPB – August 2021 Market Update

Important Footnotes and Disclosures

1. Source: Preqin Pro, based on returns reported to Preqin
2. https://ycharts.com/indicators/sp_500_pe_ratio_forward_estimate
3. Source: Preqin Pro.

 Strategy Definitions

Equity Strategies – Discretionary and systematic approaches seeking to generate positive absolute returns through investments in a range of equity markets

Event Driven – Strategies seeking to generate superior risk-adjusted returns by exploiting a wide spectrum of transformative corporate events.

Relative Value – Relative value strategies generate profits by capturing price differences between two closely related securities. These strategies therefore tend to use arbitrage.

Macro Strategies – Macro strategies hedge funds are actively managed funds with the primary aim of profiting from the broad market swings caused by political or economic events. Macro funds tend to participate in all major markets – equities, bonds, currencies, and commodities – using financial instruments to maintain long and short positions based on their research of the global market environment.

CTA / Managed Futures – Managed futures funds, run by commodity trading advisers (CTAs), tend to use a proprietary trading system to forecast market trends and determine which trades to make.

Credit Strategies – Credit strategies hedge funds invest solely or primarily in debt instruments, with the aim of profiting from inefficiencies in lending, taking long or short positions in the price of the derivative.

Niche Strategies – Niche strategies hedge funds concentrate on specific, small market niches such as cryptocurrency, insurance-linked securities, or real estate.

Multi-Strategy – a fund that invests across multiple hedge fund strategies.

Fund of Hedge Funds – a fund that invests in multiple underlying hedge funds.