FORECASTS & TRENDS E-LETTER
by Spencer Wright
December 10, 2024

IN THIS ISSUE:

The Most Overused Term in Finance
The Origin of Hedge Funds
The Global Macro Fund
The Fund of Funds
Are Hedge Funds Worth It?
AI Holiday Fun

 

This is the latest installment in our series on alternative investments. You can find the original overview here and our last article on real estate investing here.

The Most Overused Term in Finance

Hedge fund is, without doubt, the most overused term in all of finance. It seems like every strategy that uses active management or that is the least bit unconventional in approach or investments utilized is lumped into this nebulous category.

Here is a modern definition of a hedge fund: A hedge fund is a type of investment vehicle that pools money from investors, such as institutional investors, high-net-worth individuals, and pension funds, to invest in a diversified portfolio of assets. Hedge funds aim to generate absolute returns, regardless of market conditions, by employing various investment strategies and techniques. (Source: Investopedia)

That explanation is very generic. It could be invested in almost anything, which makes sense given the overuse of the term. And to be fair, there are many types of hedge funds. Let’s look at the origin of hedge funds, what they are today and if they are worth all the bother and expense.

The Origin of Hedge Funds

In the 1940s, Alfred Winslow Jones created the market neutral portfolio. Jones would buy long and sell short stocks simultaneously. This shifted portfolio risk toward individual stock selections and away from the risks of the general market.

In 1952 Jones added leverage and converted the fund to a limited partnership, creating the first pooled investment vehicle. Jones also added an incentive fee of 20% on gains. Hedge funds took off in the mid-1960s where Jones outperformed the best mutual funds of the day by 44% over a full market cycle. One of the more famous funds of the time was the Quantum Fund, advised by George Soros.

After several ups and downs through the 70s and 80s, hedge funds went stratospheric in the 1990s. Every major fund you can name today likely came from the 90s hedge boom. Today, trillions of dollars globally are allocated to a vast array of hedge funds as the below map of allocated capital illustrates.

As you can see, North America, led by the US, represents the majority of all hedge fund allocations. But allocated into what? As I mentioned earlier there are many types of hedge funds. Let’s concentrate on two of the most prevalent fund types: the global macro fund and the fund of funds.

The Global Macro Fund

A global macro fund is an investment strategy that leverages macroeconomic and geopolitical data to analyze and predict moves in financial markets. It focuses on large-scale or “macro” political and economic events, which can disproportionately impact certain sectors, such as energy, commodities, and currencies.

Key Characteristics Include:

• Flexibility: Global macro funds are highly flexible and opportunistic, able to invest across equities, fixed income, commodities, and currencies globally using multiple underlying strategies and instruments.
• Macro-driven themes: The strategy is based on broad macro-driven themes such as monetary policy, interest rates, inflation, unemployment, and politics.
• Active management: Global macro funds are typically actively managed, requiring a higher investment threshold and higher fees.
• Predictive analysis: Fund managers analyze various macroeconomic and geopolitical factors, including interest rate trends, international trade and payments, political changes, government policies, international relations, and other broad systemic factors.

Global macro funds can be further broken down into funds that use various approaches and techniques. Some of the most common are:

• Trend-following: Strategies aim to identify a trend that’s already formed and then follow it, using technical analysis to identify directional price moves across different markets and assets.
• Systematic: Strategies use mathematical models to analyze and predict market movements, often based on historical patterns and correlations.
• Discretionary: Strategies rely on the expertise and judgment of the fund manager to make investment decisions.

Overall, global macro funds offer a unique approach to investing, leveraging macroeconomic and geopolitical insights to generate returns. However, their success can rely heavily on the expertise and judgment of the fund manager(s) in navigating complex and rapidly changing market conditions.

The Fund of Funds

A fund of funds (FoFs) is an investment pool that invests in several different hedge funds at the same time, to try to maximize potential returns or reduce risk. This type of fund is also known as a multi-manager investment, and it allows investors to achieve diversification and an appropriate asset allocation with investments in a variety of fund categories.

Key characteristics include:

• Diversification: Invests in a portfolio of other hedge funds rather than investing directly in stocks, bonds, or other securities.
• Access: Provides investors access to underlying funds which they may not be able to access otherwise. This may include funds that are closed to new investment.
• Lower Minimums: May have lower minimum investment requirements compared to investing in individual hedge funds.

Some common FoFs types include:

• Conservative FOFs: Invests in funds that generally engage in more conservative strategies such as Equity Market Neutral, Fixed Income Arbitrage, and Convertible Arbitrage
• Market Defensive FOFs: Invests in funds that generally engage in short-biased strategies such as short selling and managed futures
• Strategic FOFs: Invests in funds that generally engage in more opportunistic strategies such as Emerging Markets, Sector specific, and Equity Hedge

Are Hedge Funds Worth It?

Hedge funds, in their various forms, are complex investments. As such they are not right for all investors. Some funds cater to institutions and the ultra-wealthy, while others are available to a wider range of investors.

Benefits of hedge funds in general:

• Can offer diversification and an asset allocation with investments in a variety of asset categories.
• May provide higher returns than investing in individual more traditional assets.
• May provide absolute returns as opposed to relative returns.
• Can have low to no correlation to traditional equity and debt markets.

Drawbacks of hedge funds in general:

• Significantly higher fees compared to investing in more traditional assets.
• Are often complex and understanding the underlying strategies and risks can be a challenge.
• Are almost always illiquid to some degree. It is very important to request a liquidity schedule prior to investing.

Are hedge funds worth it? The answer is – maybe. Like all investments, hedge funds are not for everyone. However, many are more accessible now with lower minimums, investor friendly liquidity schedules and better tax treatment.

AI Holiday Fun

If you have read my past letters you know that I can’t help myself when it comes to seasonally derivative AI prompts. I asked MS Copilot to render an image based on a Happy Hedge Fund Christmas. Behold the result:

Thanks for reading,

 

Forecasts & Trends is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.