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How to Use Hedge Funds in a Portfolio Context

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How to Use Hedge Funds in a Portfolio Context For UBS marketing purposes We expect positive hedge fund alpha generation for 2021, amid high dispersion and low intra asset class correlation. (Keystone) Hedge funds How to use hedge funds in a portfolio context 19 March 2021, 4:33 pm CET, written by UBS Editorial Team Hedge funds as an asset class are not monolithic. They serve various investment purposes depending on who invests in them, with some investors seeking a substitute for equity or credit and others valuing their diversifying properties. We explain what investors need to observe when building allocations relative to their portfolio needs and goals. Investors' interest in hedge funds is higher today than in previous years, according to recent surveys. This shouldn't come as a surprise given the asset class's robust performance in terms of risk mitigation during the pandemic-induced market sell-off in February and March of last year, and its strong alpha generation throughout 2020. Index performance translated into good returns for investors across strategies, with the average hedge fund, as measured by the HFRI fund weighted index, returning 11.8% in 2020. Looking at 2021 so far, sentiment is unlikely to have changed materially, with index returns for most strategies indicating a good start to the year. This doesn't mean that everything will necessarily be smooth sailing from here, and data from recent surveys don't capture the latest dispersion of hedge funds in January. But while some equity hedge strategies suffered losses during a volatile January, they managed to recoup them the next month. Meanwhile, event-driven strategies and CTAs turned in year-to-date robust performances through February. So when allocating to hedge funds, investors need to familiarize themselves with the role each hedge fund and strategy can perform and build their allocations relative to their portfolio goals and needs. Hedge funds as an equity or credit substitute: Hedge funds can serve various roles in a portfolio—as diversifiers, risk mitigators, or asset class substitutes. According to a Barclays survey, most investors see more than one role for their hedge fund allocation. But family offices appear to favor strategies that are more of a substitute for equities and credit. These often include more directional managers in the equity or credit long/short space with a higher beta to market indexes, and they are often used to express a sector or a regional preference (e.g., China, Tech/Healthcare). Hedge funds as diversifiers: Institutional investors such as pension funds and insurers typically focus more on the diversifying properties of the asset class. Here, funds that exhibit either low market directionality or seek to generate For UBS marketing purposes returns across different asset classes and strategies are typically preferred. Such strategies, which include equity market neutral, discretionary, or multi-strategy funds, recorded the strongest interest in Barclays’ latest investor survey. Hedge funds as a risk mitigator: Investors also look to hedge funds as a way to mitigate downside risk and add asymmetric returns in their portfolio. In all the major crises in recent decades, hedge funds have provided downside protection, and 2020 was not an exception. Some strategies, notably in the macro and relative value space, can exhibit negative correlation to market movements and may have the potential to deliver positive returns in down markets (e.g., tail risk or CTAs). We expect positive hedge fund alpha generation in 2021, amid high dispersion and low intra asset class correlation, a view many hedge fund allocators share. While equity long/short alpha has been challenged in early 2021, particularly on their short positions, the situation has reversed, with longs outperforming the markets and shorts underperforming. Meanwhile, alpha generation in other strategies has remained healthy. Therefore, when building up their allocations, investors should not only focus on their goals and needs, but also take a diversified approach to individual hedge fund managers and strategies. For more on this topic, please refer to our "Q&A: What do allocators use hedge funds for?". For more on how to invest in private markets, click here. Important information As a firm providing wealth management services to clients, UBS Financial Services, Inc is registered with the U.S. Securities and Exchange Commission (SEC) as an investment adviser and a broker- dealer, offering both investment advisory and brokerage services. Advisory services and brokerage services are separate and distinct, differ in material ways and are governed by different laws and separate contracts. It is important that you carefully read the agreements and disclosures UBS provides to you about the products or services offered. For more information, please visit our website at www.ubs.com/workingwithus. © UBS 2021. All rights reserved. UBS Financial Services Inc. is a subsidiary of UBS AG. Member FINRA/SIPC. There are two sources of UBS research. Reports from the first source, UBS CIO Global Wealth Management, are designed for individual investors and are produced by UBS Global Wealth Management (which includes UBS Financial Services Inc. and UBS International Inc.). The second research source is UBS Group Research, whose primary business focus is institutional investors. The two sources operate independently and may therefore have different recommendations. The various research content provided does not take into account the unique investment objectives, financial situation or particular needs of any specific individual investor. If you have any questions, please consult your Financial Advisor. UBS Financial Services Inc. is a subsidiary of UBS AG and an affiliate of UBS International Inc..
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