![]() The views and opinions expressed above are those of the portfolio management team at the time of writing and are subject to market, economic and other conditions that may change at any time and, therefore, actual results may differ materially from those expected. There is no guarantee that historical risk and rate of return will persist in the future. Drawdown protection is a vague goal that does not account for important features of hedge fund investing and must be linked to specific aims.ġSee “Liquidity: At What Cost?” Prequin Hedge Fund Spotlight, December 2012.Īll information contained herein is based on past performance and is not intended to be indicative of future results. Since strategies vary considerably in the hedge fund universe, investors must clearly define their objectives and constraints when considering an allocation to hedge funds. Investing in some hedge fund styles can provide significant enhancements to diversified portfolios, especially during times of equity market distress. Performance can vary greatly from traditional equities, but this does not mean that these funds will provide downside protection during equity sell-offs. This ability to quickly invest in unique opportunities is one of the key benefits we value in our hedge fund allocation. For instance, many hedge funds were able to profit from the collapse in the mortgage-backed securities markets in 2007–2008 or to invest in distressed debt and post-reorganization equities in 2009. ![]() There is evidence that investors can obtain greater protection from long-term drawdowns if they have enough staying power to sacrifice daily and weekly liquidity for monthly liquidity.1įinally, certain hedge fund strategies may be flexible enough to take advantage of dislocations in asset classes that are unavailable through traditional investment vehicles. This results in investors raising capital from relatively cheap assets (discounted equities) while maintaining positions in hedge funds that did not significantly decline to meet any cash needs.Īccess to cash should be factored into the objective of downside protection, and the liquidity of the “hedge” must match the need for cash. While many hedge funds control losses during equity market drawdowns, withdrawals may be unexpectedly limited during these times. Many investors fail to include liquidity concerns when attempting to protect their portfolios from downside risks. We believe the positives for these strategies outweigh the negatives. Since there is no “free lunch,” the higher volatility profile of systematic strategies may be the cause of portfolio drawdowns, as well as protection against them, depending on the market environment. Systematic funds provide diversification benefits to traditional portfolios because they have average realizable returns above the beta-adjusted market return and are expected to positively contribute to portfolio performance over time. However, from 2011 through early 2014, they contributed significant negative returns to portfolios before rebounding in late 2014 through early 2015. ![]() During the financial crisis, they were highly liquid, had limited equity exposure and performed well. For instance, many liquid systematic funds (trend-following and other related strategies) provide the first and second kinds of downside protection. The decrease in downside risk without sacrificing realizable return cannot be the result simply of a beta substantially below one, and may not be present in all volatile markets. ![]()
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