By: Emma Botha, Investor Relations at Amplify
Blending hedge funds is like a political coalition, without the volatility and without compromising returns. You might be intrigued to discover the unexpected parallels between the inception of the new Government of National Unity and the blending of hedge funds.
Just as the ANC, DA, EFF and MK parties bring their distinct nuances to the unity government – some more palatable than others – different hedge fund strategies also bring something unique to the table. Some strategies (and political factions) inject a dose of volatility, some introduce a hint of unpredictability, and others serve as a pillar of reliability – slightly boring and often overlooked until uncertainty arises and stability is paramount.
However, whereas different ideologies and policies can create friction between political factions, the same does not hold true when blending hedge funds. In fact, the more divergent their strategies, the better they work together.
We all know that we should not put all our eggs in one basket, and most investors follow this principle religiously when it comes to traditional investment vehicles. But when it comes to hedge funds, investors tend to stick to one, which can be as exciting as going to the races but can also often leave you out of pocket. What makes matters worse is that investors tend to opt for the ‘racier’ funds, which come with great returns but high levels of volatility. As soon as a fund’s returns start hitting a rocky patch, as they inevitably will, investors become squeamish and often opt out, locking in material losses. This results in a seriously bad investor experience, which is why we suggest a different approach.
At Amplify, we always recommend blending hedge funds, in the same way as you would blend four or more balanced funds, as it significantly reduces the volatility associated with hedge funds and improves return outcomes. Diversification is key, and just as relevant when investing in alternative asset classes as it is when investing in traditional investment vehicles.
However, diversification is unfortunately not as simple as investing in four or more different funds and hoping for the best. While this approach will almost certainly provide better outcomes, you would achieve a much better outcome by seeking hedge funds that follow unique approaches and behave differently to market movements. Simply put, you do not want to blend funds that all perform well, or all perform poorly, at the same time.
The table below illustrates the benefits of blending uncorrelated strategies. Fund A to E represents five Amplify hedge funds, each with a unique strategy and risk profile, and the blended portfolio is an equally weighted blend made up of these five strategies.
While the individual funds come with significant volatility, when you blend these uncorrelated strategies, improving diversification, the total risk in the portfolio is less than the sum of its parts. In addition, the maximum drawdown of the blended portfolio is significantly lower than that of each individual fund. Lastly, you have not compromised on returns, but more importantly, due to the low volatility of the blend, the journey will be much smoother than had you only invested in any one of the individual funds.
To summarise, the more divergent the strategies are, the better the outcome, and as with any successful union, striking the balance between the steady eddy, the slightly unpredictable, and the slightly erratic is key.
For disclaimer, please visit www-adm.amplify.co.za/hedge-funds-disclaimers/