Trending
Written by: Deshawn Peterson | PPB Capital Partners
If you’ve picked up a financial trade publication, listened to a podcast or scrolled the news about the markets over the last few months, the odds are pretty good that one of these topics was the above-the-fold headline, subject or lead story:
- Inflation.
- Market volatility.
- Rising and falling gas prices.
- Interest rates.
- The Fed.
The notion of doom and gloom has become engrained in our psyche because, quite frankly, the news hasn’t been great. But we’re here to change that point of view and shine light on an asset class that has produced positive, and mostly under-the-radar headlines: hedge funds.
The conversation around whether hedge funds are appropriate for most main street investors (they are), or if hedge funds have enough liquidity to satisfy the needs of non-institutional investors (they can), or if hedge funds truly do lower portfolio risk (they do) can be a topic for another day. Today’s topic is to cover the very basics of hedge funds.
What is a Hedge Fund?
It’s hard to define what a “typical” hedge fund is because they can invest throughout the market and in just about any strategy. There are, however, some characteristics that are common:
- Only “accredited investors” may invest in them
- They take on public market investments instead of private equity investments (which can be illiquid)
- They implement nontraditional investment strategies to lessen an exposure to risk
- They pool assets from multiple investors with a large focus on return potential
A hedge fund is designed return a profit to the investor no matter if the market is up or down, making it resistant to the type of volatility we’ve seen in recent headlines. The portfolio make up of the fund is very diverse and not focused on a sole asset class. By its very nature, it would qualify as a less-risky investment than other vehicles.
Common Investment Strategies in Hedge Funds
Within a common hedge fund, there can be investments in many different strategies. The most recognizable strategies are:
- Equity – public market investing in both long and short positions to reduce the amount of risk and increase the potential for return
- Event-driven – when a fund manager foresees a single event (an acquisition, bankruptcy, a change in management structure) will potentially have a positive impact on the investment
- Macro – studying happenings around the world (political unrest, natural disasters, etc.) and predicting if those events will cause a shift in financial markets, exchange rates, interest rates, etc.
While these are only a few of the most common hedge fund strategies, there are many others that can create a variety-driven set of investments. The diversity of the portfolio make up is what gives it its risk-mitigating qualities.
Fitting Hedge Funds into Investor Portfolios
Investors qualified to invest in hedge funds are known as “accredited investors,” meaning they have a net worth of at least $1 million (excluding their home), singular annual income of $200,000 or combined income with their spouse of $300,000 or more. Implementing hedge funds in a portfolio gives exposure to alternative asset classes that commonly have less correlation to the returns of traditional markets (stocks, bonds, cash, etc.). They provide a level of diversification that can reduce overall risk and give the investor the potential to capitalize on returns.
There is a place for hedge funds in an investor’s portfolio. But before considering such an investment for an investor, it’s imperative that you know their objectives. Are they are seeking income, protection against downside risk, growth, return enhancements or just an opportunity to enter unique markets? The alternative investment space is big enough that there are suitable hedge funds available that can help them meet their objective.
The potential of boosting returns when investing in hedge funds can be a delicate balance of risk vs. reward. As a wealth advisor, your role is to find a suitable strategy for your investor to maximize current market conditions, manage risk and maximize return. If you have an investor interested in a hedge fund, it’s a conversation worth having. It is an asset class that has proven to add value to many investment strategies.
Related: The Good, Bad, and Ugly of Adding Tax Services to Your Practice
Deshawn Peterson joined PPB Capital Partners in 2022 and has more than a decade of experience in business development functions ranging from technology to financial services. He supports PPB’s client facing associates and manages a centralized reporting process that encompasses marketing, advisor relations, fund manager analysis and other initiatives related to PPB’s KPIs. He can be reached at dkp@ppbadvisors.com.