Investors allocating assets to hedge funds should do so via fund-of-funds vehicles to diversify manager style and risk exposure, according to research houseAssirt.
However despite the diversification benefits, along with access to funds that may otherwise be unavailable to retail or Australian investors, Assirt warns of some potential pitfalls of taking the fund-of-funds route.
Most notably an additional layer of fees, a lack of transparency in the nature of the investments and risk profiling of individual managers, and a reliance on the fund-of-funds manager to assess the integrity and skill of the underlying managers, leaving the investor with no relationship with the underlying managers.
“We recommend that more than one single strategy manager be employed if an investor is focused on risk reduction, as a combination of strategies available through a fund-of-funds [manager] may be more appropriate,” Assirt says.
However the research house also argues that regardless of whether investors allocate to a single strategy manager or adopt a ‘manager of managers’ approach, they should approach hedge funds with a balanced view and understand that there are no “free lunches”.
“Whether an investor chooses a fund-of-funds or a single manager depends on their objective and risk and reward profile. An investor seeking to enhance returns while reducing risk may choose a single manager strategy, while those seeking to reduce risk would benefit from a fund-of-fund, though each method has advantages and concerns.”
While there is the potential to earn superior risk adjusted returns, there needs to be thorough research ahead of investing and ongoing monitoring to avoid potential disasters, Assirt says.
The group, based on its global research, recommends an allocation to single strategy hedge funds of between 5 and 10 per cent of a portfolio with a maximum exposure to a single manager of 2.5 per cent.
Additionally for allocations to market neutral strategies or funds with low market beta, Assirt believes there is no value in diversifying across strategies and recommends investors diversify across managers. Though for higher beta funds, investors should allocate across strategies and managers, it says.
However “investors looking for more stable returns while reducing risk, including business risk, should consider allocating 5 to 10 per cent to a fund of hedge funds, with a maximum allocation to each fund-of-fund manager capped at 4 per cent”.
