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The case for hedge funds

An allocation to the right hedge funds can help pension schemes prepare for a more uncertain future.

The hedge fund industry can be a daunting place. It contains thousands of funds running a multitude of different strategies that exhibit a huge dispersion of returns every year. Good manager selection is therefore key to successfully navigating the industry.

The problem is that most managers are very experienced at writing good marketing documents and answering standard questions. Those that look good on paper can often turn out to be poor investments over the long-term.

This is why a more unconventional approach, be it through different questions or channels, can often help to better identify those who are likely to deliver consistent outperformance over time.

Gaining a firm grasp of how a strategy works and when it will both outperform and underperform is a must. However, it is also essential to understand the individual behind the strategy.

In our experience, we think that some of the best investment managers are characterised by a number of attractive character traits. These include an obsession about excellence, an openness to challenge and a willingness to learn from mistakes. Such traits can help drive a firm-wide culture of continued improvement and development which ultimately enhances the ability to generate returns over time.

Assessing these traits can take many hours of face-to-face meetings. But if you are seeking quality over quantity, we think this is an essential part of identifying world-class investment talent.

In summary, the hedge fund industry has not lived up to its promises over recent years. But there remains a select group of truly talented managers that have. Following strong market rises over recent years, the downside risks have grown and the future looks increasingly uncertain. An allocation to good quality hedge funds can help pension schemes better manage these risks.

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