A Look at Hedge Funds and Where Alternative Investments Fit into Your Portfolio Today

With the current wild Euro-debt ride we’ve been on that’s had everyone stumbling all over the market, what better time than now to reevaluate where alternative investments stand in your portfolio?

Alternative investments are basically any component of an investment portfolio that isn’t traditional long-only stocks or bonds. Their primary purpose is to provide diversification within an investor’s portfolio by giving them a place to allocate their money that is not correlated to the stock market. Today, with the prevalent volatility of stocks and their concert movements with the European debt crisis, alternatives have been generating traction amongst weary investors. Of course, they can also be influenced by current global economic conditions, but not in equivalence with stocks and bonds.

Most recently, the hedge fund industry’s been receiving a fair amount of attention, as the media seems to like tracking its performance quite closely.  The Wall Street Journal provides a good summation of a June 2012 Citigroup survey entitled Institutional Investments in Hedge Funds. In it, forecasts were made that the current hedge fund industry could very well double in size its managed assets to become over $5 trillion within the next five years.

The survey gathered information from 80 hours of interviews with 73 investors, consultants, and money managers who see the hedge fund industry progressing beyond its formerly private, limited access status into a more mainstream investment option. Where before, hedge funds made up a smaller portion of alternative investments, they are now making moves to a more central position within portfolios. With this transformation comes stricter regulation, compliance demands, and transparency within the industry, all additions that will hopefully help in legitimizing hedge funds and projecting them in a less risky light.

One of the stronger historic examples illustrating how hedge funds have come in clutch during rough market times was back in the early 2000’s as portfolios that had them incorporated were able to out perform their traditional 60 percent equity/ 40 percent bond structured brethren portfolios. This induced a surge of more than $1 billion in capital flow directed into this asset class for the proceeding few years.

The idea of today’s projected five-year hedge fund boom is based primarily on a predicted increase of established institutional investors using them as a diversification and risk management tool. This alone could generate $1 billion in hedge fund strategy allocations, while another $2 billion could come from these funds marketing themselves as a more commonplace regulated alternative investment product competing with traditional asset managers.

In a June 11 MarketWatch article announcing how hedge funds are establishing a presence in China’s growing alternative investment industry, Hedge Fund Association (HFA) president Mitch Ackles states that globally, hedge funds are moving into the investment mainstream. PerTrac, a leading worldwide aggregator of hedge fund data, found that there were 658 hedge funds in China as of April 2012; half of them having been formed within the past two years.

In the US, Neuberger Berman made a bit of investment history by being the first asset manager of its caliber (US$199B in AUM) to create the first Multi-Manager Fund. This fund is basically a hybrid investment mechanism structured after a mutual fund, but operated using hedge fund strategies. It is run by a group of fund of hedge fund professionals who feel that this type of investment should be available to a wider range of investors who in the past, have not been able to access hedge funds. The benefits of this hedge fund inspired investment vehicle are daily liquidity, lower investment minimums, full portfolio transparency, and no performance based management fee.

Neuberger Berman’s Multi-Manager Fund could be a big step in the direction of closing the gap between non-high-net worth investors and the ability to access hedge fund strategies. This is really fascinating to me because it is the same concept that inspired the creation of Currensee. Currency trading, a different type of alternative investment, was at one time only possible for professional foreign exchange traders, multinational banks, and high-net worth investors. Now, with the advent of trade replication software, investors of any kind can have equal access the world currency markets.

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