Lately the news has reported that some pension funds are eschewing Hedge Funds as an investment vehicle. As they have matured they have been used by a growing number of investors, large funds and high net worth families. This trend seems to be continuing and may increase to over 85% of all institutional funds.
Due to the amount of funds now using hedge funds as a means of investment, it’s important to continue to understand what a hedge fund is and how it can create returns for an investment class. Not surprisingly, there are a number of different kinds of hedge funds in the market place.
A Long/Short Equity fund is one where the investment manager takes a long or short position in equity securities that are deemed to be undervalued or overvalued. The manager can adjust the amount of long v. short to lock in value depending on whether the market is rising or falling. The investment manager depending upon their risk/return objectives can run the investment portfolio with a number of ranges of gross and net exposures, typically net long but in the oft occasion can be net short as well.
Institutional investors today are confronted with achieving acceptable rates of return and the need to mitigate downside risk. Pension funds in this low interest rate environment are seeing their underfunding status worsen, and endowments are needing to find other means with which to meet their annual spending needs. Therefore it is important for institutions to ferret out and employ investments that can meet their targeted rates of return without taking on an inordinate amount of risk. The choice of the appropriate hedge fund to either provide risk/adjusted alpha versus equities or a moderate fixed income like return can help institutions to reduce their volatility and enhance returns over time. Lower volatility and smaller potential portfolio draw-downs lead to a greater wealth effect and compounding of return for the institution. The consistent compounding of returns will permit institutions to better meet their liabilities and spending needs.