Long-only investment vehicles such as mutual funds, exchange-traded funds (ETFs), and separately managed accounts (SMA) are useful structures in a diversified portfolio. In a market environment conducive to “long-and-strong” or “set-it-and-forget-it” investment approaches – like the bull market following the Global Financial Crisis (GFC) – these traditional vehicles are likely to provide competitive returns.
However, over the next 10 – 15 years, many capital market assumptions are projecting equity returns to be between 5% and 6%, well below historical averages, and the correlation between equity and fixed income returns are expected to increase.1 Amid this uncertainty, fully invested, long-only investment mandates of traditional structures may be limited, and meeting investor return expectations will be difficult to achieve.
Capital market assumptions are forecasting lower returns
A robust toolkit provides more ways to win
In contrast, hedge funds offer broad diversification across multiple asset classes, styles of investment, sectors, regions, and risk-return profiles. They can go long and short, be fully invested, or fully hedged. As volatility rises and market opportunities shift, this dynamism can add significant value in client portfolios.
Over longer periods, the ability to tactically deploy capital and manage risk is a huge advantage over most long-only approaches. While the absolute return in different hedge fund strategies may be higher or lower than traditional assets, the path to success in achieving client goals is likely to be smoother through the avoidance of steep losses and excessive downside volatility. In short, hedge funds have more ways to win when compared with traditional long-only managers.
Complex investments are characterized by higher fees and less liquidity
However, this greater flexibility comes with a comparative cost. Hedge funds charge both management and performance fees; 20% of profits is the norm. They can also have lock ups and limited liquidity. Some funds require that capital be invested for a minimum of 12 months, while others utilize a “soft lock,” an option for investors to redeem during the lock-up period in exchange for an early withdrawal fee. Also, most funds do not provide position-level transparency, aside from required public filings.
By comparison, ETFs, mutual funds and SMAs charge a management fee, which varies but is significantly lower than their hedge fund counterparts; offer daily liquidity; and provide greater transparency of investment holdings.
Hedge funds offer improved risk-return potential amid uncertainty
The bull-market following the GFC was an ideal environment for most long-only structures. Stocks soared to record highs, and bonds provided income, stability, and a counterbalance to occasional equity market shocks. However, as return expectations have declined and uncertainty has increased, the value of hedge fund exposure – and the meaningful diversification it may provide – is at its highest. While this asset class may not be suitable for all investors, it can be a valuable addition to a well-diversified portfolio.
(1) Source: Based on Capital Market Assumptions from Blackrock, JP Morgan, BNY, UBS and Morgan Stanley. Updated as of June 2020.
IMPORTANT INFORMATION
This material is provided for informational purposes only and is not intended as, and may not be relied on in any manner as legal, tax or investment advice, a recommendation, or as an offer to sell, a solicitation of an offer to purchase or a recommendation of any interest in any fund or security offered by Institutional Capital Network, Inc. or its affiliates (together “iCapital Network”). Past performance is not indicative of future results. Alternative investments are complex, speculative investment vehicles and are not suitable for all investors. An investment in an alternative investment entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. The information contained herein is subject to change and is also incomplete. This industry information and its importance is an opinion only and should not be relied upon as the only important information available. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed, and iCapital Network assumes no liability for the information provided.
Products offered by iCapital Network are typically private placements that are sold only to qualified clients of iCapital Network through transactions that are exempt from registration under the Securities Act of 1933 pursuant to Rule 506(b) of Regulation D promulgated thereunder (“Private Placements”). An investment in any product issued pursuant to a Private Placement, such as the funds described, entails a high degree of risk and no assurance can be given that any alternative investment fund’s investment objectives will be achieved or that investors will receive a return of their capital. Further, such investments are not subject to the same levels of regulatory scrutiny as publicly listed investments, and as a result, investors may have access to significantly less information than they can access with respect to publicly listed investments. Prospective investors should also note that investments in the products described involve long lock-ups and do not provide investors with liquidity.
Securities may be offered through iCapital Securities, LLC, a registered broker dealer, member of FINRA and SIPC and subsidiary of Institutional Capital Network, Inc. (d/b/a iCapital Network). These registrations and memberships in no way imply that the SEC, FINRA or SIPC have endorsed the entities, products or services discussed herein. iCapital and iCapital Network are registered trademarks of Institutional Capital Network, Inc. Additional information is available upon request.
© 2021 Institutional Capital Network, Inc. All Rights Reserved.