Mercer | Hedge Funds 101

Mercer | Hedge Funds 101

Alternative Investments

Hedge Funds 101

Why should you consider including alternatives to your portfolio? How have multi-strategy funds performed over the last several years? Learn about today’s most effective hedge fund strategies and how to incorporate them into your portfolio with our “Hedge Funds 101” whitepaper, with practical tips on alternative investments, multi-strategy funds, long/short equity and event-driven strategies and distressed debt and credit opportunities.  

Introduction to Alternatives

Alternative investment strategies seek to achieve positive returns by pursuing investments that are outside the traditional long-only portfolios of equities and fixed income.

Many of these strategies have low correlations to traditional stock and bond asset classes, which helps improve return potential compared with traditional-only portfolios at equivalent risk levels. The popularity of alternatives has grown rapidly since the 2008 financial crisis. According to Prequin, alternative assets under management stands at $7 trillion in 2015.

Why Use Alternatives?

The addition of alternatives to a traditional long equity and fixed income portfolio can improve efficiency, due to alternative strategies having lower correlations with the traditional asset classes. Effective alternative strategies can offer higher expected returns per unit of risk than traditional long equity or fixed income strategies. Alternatives can also offer additional diversification benefits, including hedging against inflation, interest rate volatility, and market risk.

Other Hedge Fund Strategies

Long/short equity and event-driven strategies: Long/short equity is an investment strategy that involves buying long positions that are expected to appreciate and selling short positions that are anticipated to decrease in value.

Global macro strategies and managed futures: Managed futures strategies can include fundamental-based strategies, but they tend to be more price-based, are predominantly directional, and are nearly always systematic.

During times of significant equity weakness, global macro and managed futures strategies have tended to have a negative correlation to equities, mitigating a portfolio’s losses during tough economic times. Examples include the Russian financial crisis and Long Term Capital Management’s collapse in 1998, the tech bubble bursting in 2000 and 2003, and the most recent global financial crisis of 2007 and 2008.

Distressed Debt and Credit Opportunity Hedge Funds:  Many institutional investors have investment policies that require the sale of fixed income securities if the securities’ ratings slip below a certain level. This selling activity can create opportunities for managers to purchase credit at steep discounts.

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