Retail investors often overlook hedge funds, as these vehicles are not aimed at them. Hedge fund managers are only allowed to market themselves to wealthy investors, with many demanding a minimum stake of at least £100,000.
Hedge funds are not like the investment funds available to the everyday investor. They are lightly regulated and can invest in a wide range of assets. The most common fund used to be the long/short equity fund.
Long/ short funds buy the stocks they like best, the ones they think are going to go up, while shorting the ones they think are going to lose value: a hedged equity strategy. In theory, this strategy will lead to lower losses when the market is falling, underpinning smoother, higher returns in the long term.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Hedge funds: how to diversify your portfolio
Long/short funds still dominate the $4trn sector. Still, there are plenty of other strategies, such as algorithmic trading funds, debt-focused funds, macro funds (which trade assets such as bonds and commodities), commodity-focused funds, activist hedge funds and funds managed by short-sellers, who seek out the market’s disasters before they happen. But why would an investor want to own a hedge fund?
Put simply, hedge funds can provide diversification into various asset classes and provide exposure to different investment managers. Wealthy individuals may own stakes in several hedge funds alongside other investments to help them build exposure to trading strategies they may not understand or have the resources to trade.
Man Group (LSE: EMG) is the world’s largest publicly traded hedge-fund firm, and a good case study of how hedge funds operate. It specialises in trading foreign currencies using computer models and last year one of the best-performing investment strategies was a fund called Man AHL TargetRisk, which generated annual returns of 14.1% by trading assets such as credit-default swaps, futures contracts on stock indexes and government debt for France, Germany, the UK and the US.
Investors like this approach. The overall group’s assets under management surged by 17% last year to a record high of $167.5bn. Man Group takes annual management fees and performance fees if a certain performance hurdle is met on the funds. This is one of the easiest ways to profit from hedge funds without running the gauntlet of selecting one yourself. The stocks yield 5.7% and the company has been spending money to buy back stock.
Pershing Square Holdings (LSE: PSH) is an investment trust that follows the strategy of the Pershing Square hedge fund. It has earned one of the best returns of any investment trust thanks to its focused portfolio – another hallmark of hedge funds, as unlike open-ended retail funds they don’t need to conform to diversification rules. Over the past five years, Pershing Square’s hedge fund has returned 203.5%.
BH Macro (LSE: BHMG) is another investment-trust hedge fund. BH Macro tries to trade global financial markets, using instruments such as debt, foreign currencies, swaps and commodities to earn a positive annual return. Over the past decade the fund has returned 95.5%, providing profitable diversification to a portfolio. The trust’s sterling class is on a 12.2% discount to net asset value (NAV). If the discount stays wider than 8% over the year, shareholders are allowed a discontinuation vote in 2025. The board has bought back shares to try to close the discount.
Then there is Tetragon Financial Group (LSE: TFG). While technically not a hedge fund, the close-ended company invests like one. Its portfolio is a mix of private assets, bank loans, venture-capital equities and real estate. Since the firm listed in 2007, its NAV has risen by 426%, more than double the return of the MSCI All Country World index. The shares yield 4.6% and the fund has been buying back shares. The shares currently trade at a 69% discount to NAV.
This article was first published in MoneyWeek's magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
-
CrowdStrike IT outage: a global meltdownMillions were affected by the CrowdStrike IT outage recently, which grounded flights and took the news off the air. Was this just a hiccup or a warning of much worse to come?
-
Revolut finally bags a UK banking licence – what's next for the fintech?Revolut has finally been granted a UK banking licence following three years of negotiations with the regulator
-
UK mid-caps: an improving outlookUK mid-caps have perked up and the rally may run further, but long-term investors should remain selective
-
The tobacco industry is going smoke-free - how to profit from itTobacco companies have realised their traditional products are on the wane. But new opportunities have opened up – and should prove lucrative
-
The AI boom is on borrowed timeThe hype around the AI boom could be on its way out – but why?
-
Diploma: a blue-chip set for strong growthDiploma, whose niche products include seals and fasteners, serves an array of growth markets. Should you invest?
-
Is local production making a comeback?Companies return production closer to home and shorten their supply chains due to the pandemic and geopolitical turmoil. How should investors react?
-
Paramount merger: what does this mean for its shares?The Paramount merger with Skydance Media will create a group worth $28 billion. But what will this mean for its stock?
-
Are emerging markets ready to rally?Is it time for emerging markets to shine, even though global markets haven't had a good run?
-
Small caps are invaluable for your portfolioSmall caps have been underperforming as of late – but they're still a diversifier to consider for your portfolio
