Hedge funds usually target positive absolute returns rather than seeking to outperform a specific benchmark of one sort or another. With low correlation to traditional equity and fixed income investments, hedge funds can add valuable diversification benefits to a portfolio. By grouping a number of skilled hedge fund managers together, with each pursuing one or more of a number of unrelated strategies, a fund of hedge funds amplifies portfolio diversification benefits and provides ongoing monitoring and risk management capabilities.
Getting access to the best hedge fund managers is not always easy, nor is choosing among the literally thousands of managers around the world. Obstacles to hedge fund investing include identifying managers, high minimum investment requirements, lengthy lock-up periods and the risk of catastrophic losses, just to name a few.
Investing in a fund of hedge funds can resolve these problems. The value of the product is largely captured in three ways: portfolio construction, liquidity, and monitoring. Portfolio construction means a fund of funds manager should have the relationships in and knowledge of the industry to identify the right hedge funds, and then combine those funds in a way to meet the portfolio’s risk and return objectives. Liquidity is important as a fund of hedge funds is often able to offer entry to its investment vehicle with lower minimums than some individual hedge funds, and may have shorter or no lock-up periods or withdrawal penalties. Monitoring is also an important service that a fund of fund provides. While diversification of the portfolio with a number of hedge funds reduces exposure to big losses at any one fund, ongoing monitoring via phone calls, office visits, and underlying security-level transparency provides a higher degree of investment oversight.
Employing a skilled fund of hedge funds manager who has the right infrastructure, personnel, risk management capabilities and business model can create significant value. As market participants continue to discover this value, funds of hedge funds are growing in profile and assets managed. Fees, track records, and manager experience are all important considerations when choosing a fund of hedge funds.
David Lester is a Vice President at Northern Trust Global Advisors. Based in the Toronto office, David leads the asset management sales effort at Northern Trust in Canada. With a focus on providing innovative investment and outsourcing solutions to the marketplace, David will be working closely with pension plan sponsors, charitable organizations, and other institutional investors. David started his investment career in 1996 with a retail mutual fund company. Prior to joining Northern Trust, David spent 12 years at SEI, most recently as the Director of National Accounts where he lead the firm’s institutional sales and marketing efforts.
David has authored a range of articles on pension-related topics in addition to speaking at industry conferences. He is a past chair of the Ontario Regional Council of the Canadian Pension & Benefits Institute and is a member of the Toronto CFA Society.
David holds a Bachelors Degree in Mechanical Engineering from McGill University where he was awarded the British Association Medal for Great Distinction. David graduated from INSEAD in Fontainebleau France with distinction, where he received a Masters Degree in Business Administration.
This material is directed to eligible counterparties and professional clients only and should not be relied upon by retail investors. It is issued by Northern Trust Global Investments Limited, authorised and regulated by the Financial Services Authority in the United Kingdom. Registered office: 50 Bank Street, Canary Wharf, London E14 5NT, registered in England 03929218.
Read the UK Stewardship and Proxy Voting guidelines by Northern Trust Corporation affiliates.