Investor sentiment is turning back in favour of hedge funds as the reformed sector puts some shine back on a reputation dimmed during the post global financial crisis (GFC) era, according to Mercer global chief investment officer, Hooman Kaveh.
In NZ last week on client visits, Kaveh said institutional investors were slowly regaining enthusiasm for hedge funds as a portfolio diversifier as part of the general trend towards alternative assets.
“It takes a while to rebuild confidence,” he said. “But we’ve been talking to clients over the last six to eight months about adding hedge funds in their portfolios – and some clients have invested.”
Compared to the pre-GFC period, Kaveh said the hedge fund sector has evolved more “institutional like” arrangements featuring stronger governance, enhanced transparency and – perhaps most importantly – lower fees.
The infamous ‘2 and 20’ fee structures levied on opaque hedge fund strategies that ultimately underperformed saw many investors ditch managers in the wake of the 2008 crisis.
In the Darwinian environment that followed many hedge funds either fell over or simply returned capital to investors, leaving “only the fittest” as survivors, Kaveh said.
“Investors can now benefit from the better version of hedge funds,” he said.
It has helped, too, that hedge funds booked respectable returns during the difficult 2021-22 years.
Mercer groups hedge funds into about five different universes – global macro and common-trading advisers (CTAs), for example – with a galaxy of 10 to 15 star managers in each.
A typical Mercer multi-manager hedge portfolio would contain about 15 to 20 underlying funds, Kaveh said.
But hedge funds form just one element of the wider alternatives subset that will become increasingly important for investors amid radically altered background conditions.
The Mercer CIO said stubborn inflation – likely to linger between 3 and 4 per cent over the next five to 10 years – combined with ‘higher for longer’ interest rates (at least compared to the near-zero experience of the post-GFC and COVID years) will challenge conventional strategies framed around listed shares and fixed income.
“Investors will have to think how to build resilient portfolios in a moderate interest rate environment,” Kaveh said.
Mercer has long had a higher weighting to alternative assets than most competitors in multi-manager portfolios, including its KiwiSaver scheme, but the approach has likely held back performance during the easy money period of the previous 10 years or so.
But Kaveh said hedge funds, real assets such as property and infrastructure, as well as private equity and debt will all offer opportunities for investors as they negotiate the changing world.
And even within traditional asset classes investors will have to rethink strategies, he said, with emerging markets equities, for instance, looking attractive compared to developed country shares.
Some investors are also re-weighting back to value, Kaveh said, after a decade of underperformance has seen many portfolios skewed to growth equities.
In the shorter-term he said the bounce in risk assets this year, which took many investors by surprise, is showing signs of widening beyond the narrow ‘super seven’ surge underpinning the 2023 share market performance to date.
“A small number of large cap US stocks have driven most of the returns this year but it’s important that broadens out – it’s unhealthy for investors if it doesn’t.
“We are starting to see a broader move in markets, which should bring more sustainable returns.”
The Dublin-based Kaveh has served as Mercer global CIO since 2017 in a career with the firm dating back to 2006.