Financial advisers say it’s never safe to hedge your bets on any one investment vehicle. So as you assemble your financial toolbox, they recommend only certain investors sparingly add hedge funds as a tool to diversify their portfolios. “Hedge funds are not for every investor,” cautions Maurice Quiroga, executive VP and managing director at PNC Wealth Management. “But for ultra-high net-worth individuals, they can lower the risk of your overall portfolio of stocks and bonds.”
About 300 hedge funds—privately managed investment vehicles primarily used by institutions and wealthy individuals—emerged in the ’90s, and have seen tremendous growth the past 20 years, skyrocketing to 10,000 in the early 2000s, and now leveling out to about 7,500. According to a hedgecompany.net survey, 81 percent of endowments and foundations plan to use hedge funds this year. But Quiroga points out that institutions are different than individuals when it comes to these investment tools.
While local financial firms have seen a recent uptick in hedge fund use among their clients, advisers warn investors that this type of asset is not for everyone. Those best-suited for this investment tool are at a high level of financial sophistication, Quiroga says, with at least a million dollars in liquid net-worth beyond their home and a steady annual income of $200,000 to $300,000. Hedge funds are the wrong tool for investors looking to fund a long-term goal, such as college or retirement, he adds. “Rules vary by fund, and sometimes they only can be accessed annually or quarterly; it’s different for every fund.” Quiroga also warns that hedge fund managers can have years of experience—or no experience—and benefit from performance-based fees. “Hedge funds can provide tremendous growth opportunity, but also can offer tremendous risk if not chosen wisely.” Quiroga notes that investors should consider this vehicle under the advice of their investment professional, who can help analyze and determine if the client and his or her family fit the risk profile.
Brad Koeneman, a principal at Moneta Group, agrees. He says those looking to add hedge funds to their portfolios should first do their research and find the right resources to guide them through the process. “Don’t do it just because it sounds sophisticated—because really they are complex and they are more expensive,” Koeneman notes. “But we do think they’re a good value, and they are different from what stocks and bonds give you.” At Moneta Group, hedge funds are tools that are used conservatively to diversify the client’s investment toolbox. “Many of our clients are conservative investors,” Koeneman explains. “They already have achieved financial success; and while they want good returns, it’s very important they don’t have a lot of down-side risk. Many times, it’s not what you make, but what you don’t lose. These tools fall into the ‘don’t lose’ category.” Moneta Group uses hedge funds to dampen the risk in the client’s portfolio. “For the last five years, stocks have basically gone straight up—by 200 percent—so all that people needed to do was own stocks,” Koeneman says. “But there are blocks of time where stocks don’t do very well; and when those times happen, a hedge fund could be a shock absorber.” The stock market is “already overdue for a correction,” Koeneman continues, “and whenever the inevitable pullback happens, hedge funds can help.” Historically, hedge funds also have risen when bond markets are decreasing in price, he adds.
While hedge funds are not ‘homerun tools,’ they often can give investors moderate returns independent of the market’s fluctuations, Koeneman says. “Hedge funds will see returns when the market is more volatile—not when it is good. This is a year when you could get significantly more volatility, and that’s where a tool like a hedge fund could benefit you.” Quiroga agrees, adding that hedge funds do well amid rising interest rates by the Federal Reserve—a time we are heading into now. “One can’t guarantee the performance of a hedge fund; but if history proves itself correct, they could be beneficial in the coming time period.”