Do hedge funds make portfolios more or less risky? (2024)

Hedge funds can help smooth portfolio returns, add diversification, and grant access to parts of the market that are often off limits to many investors. Certain hedge fund strategies are also well-placed to outperform in market downturns. We see the best current opportunities in macro, multi-strategy, and credit funds.

Hedge funds come with a range of potential pitfalls, which need to understood and managed.

  • Hedge fund strategies that invest in illiquid assets, such as distressed debt, can limit investors' access to their money in a fund for 1–3 years.
  • Hedge funds often don't share details of their strategy, making funds less transparent to investors.
  • Complexity is an additional risk, with some strategies using more exotic instruments that individual investors may not understand.

But savvy hedge fund investing can smooth returns and add new sources of return.

  • Some strategies, like macro funds, can make money even in falling markets, dampening swings in portfolios.
  • Hedge funds can add sources of return beyond public bonds and stocks, while manager skill can help beat major indexes (or"generate alpha").
  • Holding a collection of hedge fund approaches—including multi-strategy funds—can help investors avoid over-concentration and achieve diversification.

So, we think the asset class can play a positive role in portfolios, both now and in the years to come.

  • With 2024 likely a year of elevated economic and political uncertainty, macro and multi-strategy funds are well-placed to exploit shifting market conditions.
  • Elevated debt levels and interest rates above pre-pandemic levels create opportunities for credit funds that take advantage of mispricing between stronger and weaker borrowers.

Did you Know ?

  • The ease of selling a hedge fund (its liquidity) depends on how the manager invests. Funds working with more liquid securities can make it easier for investors to withdraw their capital. This is often the case with Commodity Trading Advisors, who tend to invest in deep futures markets. By contrast, distressed debt funds or event driven funds—which operate in less liquid instruments—require investors to tie up capital for longer.
  • Select hedge fund strategies can outperform in hostile market conditions. Between 2000 and 2002, the bursting of the "dot com bubble" led to falls of 47% for the MSCI All Country World Index. Yet, equity market neutral funds lost just 0.4% and merger arbitrage 0.8%.
  • The 20% addition of equity hedge fund substitutes to a 60/40 portfolio lowered portfolio swings with little change in returns between 2000 and 2022. This smoothing can result in swifter compounding of returns and higher wealth over long time horizons.

Investment view

Within hedge funds, we particularly like specialist credit hedge fund strategies. Discretionary macro funds and multi-strategy funds have proven resilient during crisis periods. Investors should understand the inherent risks of hedge funds, including illiquidity, lack of transparency, and use of leverage.

Main contributors - Christopher Swann, Tony Petrov, Matthew Carter

Original report - Do hedge funds make portfolios more or less risky?, 3 January 2024.

Do hedge funds make portfolios more or less risky? (2024)


Do hedge funds make portfolios more or less risky? ›

Hedge funds are seen as too risky by some. Investors must be able to bear certain risks not always experienced in stocks and bonds. But adding hedge funds to a portfolio can reduce risks to overall wealth.

Are hedge funds more or less risky? ›

The Bottom Line. Hedge fund investing is considered a risky alternative investment choice and requires that investors can make a large minimum investment or have a high net worth. Hedge fund strategies involve investing in debt and equity securities, commodities, currencies, derivatives, and real estate.

How do hedge funds reduce risk? ›

Hedging is the process in which some studies refer to as risk management. The reason is that hedging allows organisations like hedge funds to diversify their portfolios in order to reduce risk. If hedging is done properly organisations or investors can try and provide themselves with their own type of insurance.

Which is more risky hedge funds or mutual funds? ›

Mutual funds are generally considered safer investments than hedge funds. That's because fund managers are limited in their ability to use riskier strategies such as leveraging their holdings, which can increase returns, but it also increases volatility.

Why are hedge funds considered a high risk form of investment? ›

Hedge funds are investment pools managed by managers through investments of borrowed money to maintain the value of money and profits. Hedge funds are risky because they use borrowed money to be able to buy as many assets as possible.

Are hedge fund jobs risky? ›

Risk: All else being equal, hedge funds are probably riskier because they do not control the assets they trade, and it's very difficult to beat, or even match, the performance of the public markets.

What type of risk do hedge funds have? ›

The risks associated with hedge funds include (but are not limited to) liquidity risks due to lock-up period, large sizes of positions, and the use of leverage, which magnifies profits and losses.

Why are hedge funds safe? ›

They usually outperform traditional assets, thanks to uneven strategies' sensitivity to inflation. As they are structurally long cash, hedge funds also tend to benefit from higher rates. Volatility is a decisive factor in setting an allocation's risk level and targets with major implications for alpha generation.

Why do most hedge funds fail? ›

Some strategies, such as managed futures and short-only funds, typically have higher probabilities of failure given the risky nature of their business operations. High leverage is another factor that can lead to hedge fund failure when the market moves in an unfavorable direction.

How effective are hedge funds? ›

Hedge funds offer the potential for high returns and diversification benefits, but they also come at the cost of higher fees and less regulatory oversight. As with any investment, you should do your own research to determine whether they make sense for your portfolio.

Is my money safe in a hedge fund? ›

While hedge funds are only lightly regulated and carry high inherent risks, funds of hedge funds are thought to offer security because professional managers are picking the hedge funds that make up the pools.

What is one disadvantage of a hedge fund? ›

Some of the disadvantages of investing in hedge funds include high fees, lack of transparency, and higher volatility. Hedge funds can also be more complex and harder to understand than private equity investments.

Which funds has the highest risk? ›

List of High Risk Risk Mutual Funds in India
Fund NameCategoryRisk
Sundaram Equity Hybrid FundHybridHigh
Tata Balanced Advantage FundHybridHigh
ICICI Prudential Balanced Advantage FundHybridHigh
Sundaram Balanced Advantage FundHybridHigh
7 more rows

Does hedging increase risk? ›

Hedging is a risk management strategy employed to offset losses in investments by taking an opposite position in a related asset. The reduction in risk provided by hedging also typically results in a reduction in potential profits.

How do hedge funds work for dummies? ›

Hedge funds use pooled funds to focus on high-risk, high-return investments, often with a focus on shorting — so you can earn profit even when stocks fall.

Do hedge fund managers beat the market? ›

Do hedge fund managers consistently beat the market? No, in fact, and the longer hedge funds exist, the worse they tend to do.

Are hedge funds riskier than private equity? ›

Both offset their high-risk investments with safer investments, but hedge funds tend to be riskier as they focus on earning high returns on short time frame investments. It is hard to make a generalization on the level of risk, as individual funds vary so much based on their investing strategies.

Why are hedge funds riskier than mutual funds? ›

Hedge fund managers tend to take bigger risks than mutual fund managers, using leverage and other techniques to amplify their profits. However, this means that these funds experience more volatility as a result.

Are hedge funds high-risk high reward? ›

In the world of finance, hedge funds have established a reputation for their high-risk, high-reward nature. At their core, however, hedge funds are simply pools of money controlled by professional analysts and hedge fund managers who aim to generate higher returns than traditional investment avenues.


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