As a passive watcher of the show Billions, my perspective on hedge funds took an interesting turn last week when I met a person that many claim that show is modeled after.
Now I'm not saying it was the guy - but he sure looked and acted a lot like Damian Lewis' portrayal of Bobby Axelrod. Billionaire investment gurus, even those without HBO series modeled after their lives, probably all share some traits exhibited by this character (so whether it was him or not probably doesn't matter).
What took me to New York, and to this individual's office overlooking Central Park, was a conference on alternative investments - which is a good segue into today's post focusing on hedge funds.
Taking a bird's eye view, hedge funds actually fall under the broader umbrella commonly referred to as "alternative investments" - so dubbed because of their status as an alternative to traditional investments like stocks, bonds, and cash.
The alternative category consists not only of hedge funds, but also private equity, venture capital, fund of funds, private placement debt, and managed futures (among others).
The long and short (pun intended) of alternative investments is that they may use traditional asset classes, but they often do so using more complex strategies (involving short trading and derivatives). This is one reason that the returns of alternative investments aren’t usually as highly correlated to traditional investment benchmarks (like returns on the S&P 500, for example).
If you align with the above perspective, then the addition of alternatives to a portfolio can be viewed as access to enhanced diversification. However, one must also keep in mind that alternative investments may be more volatile, more illiquid, more expensive (in terms of fees), and require longer holding periods.
For these reasons, firms in the alternative investments space tend to seek capital from high net worth individuals/entities known as "accredited" or "qualified" investors. That type of clientele is considered "more sophisticated" by regulatory bodies, which means the firms running these strategies may be subject to less onerous reporting requirements.
Interestingly, and maybe partially due to the popularity of Billions, hedge funds have been a highly-debated topic in 2016. The spotlight on hedge funds may be attributable to their overall lackluster performance in 2016, as well as some well publicized blow-ups like the price of oil, Valeant Pharmaceuticals, and the stalled Pfizer/Allergan merger.
While some may believe these events herald the end of the hedge fund era, as discussed by Dylan Ratigan and Vonetta Logan on The Long & Short Of It, my own view is that the alternative space tends to perform better during periods of increased volatility (i.e. VIX higher than low teens).
As the world's central banks step back from their historic levels of intervention, I wouldn't be surprised to see an increase in volatility as markets "normalize." Such volatility could help boost alternative investment returns (especially hedge funds) back toward their historical averages.
That outlook doesn't mean that hedge funds, or alternatives in general, are a good ongoing investment - it all depends on your objectives and risk profile. However, challenging returns in the last six to eight quarters doesn’t necessarily equate to the forthcoming extinction of these investment entities - especially given the depth, complexity and diversity of the sector (i.e. some players will survive).
As always, If you have any comments or questions on this topic we hope you’ll reach out at firstname.lastname@example.org.
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.