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Wealthy stage a tactical retreat on hedge funds

The quarterly allocation reports of TIGER 21 – a high-net-worth, peer to peer network for investors – have just been published and are a good way of getting a read on some of the themes and trends the wealthy are thinking about right now. Most of the time, the wealthy recognize opportunities (and dangers) before the general population, and they leave their footprints for others to track.

The report outlines how members' portfolios are allocated to broader market categories. While the sample size is small (about 200 individuals), it can provide a high-level overview of what the wealthy are doing with their money right now. All in all, worth paying attention to, no matter how big your portfolio is.

One trend that stands out to me in latest chart is the gradual shift into public equity, a move that has continued since the first quarter of 2011. The move has worked out well for HNW investors, as equity markets in North America have recently hit new highs.

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Of course, money going into public equity has to come from other assets. Indeed, this is what's been happening, as HNW individuals trim back their exposures in various assets (fixed income in particular) and re-allocate them to better opportunities.

One of the asset classes that they've been shifting out of is hedge funds – you can see the allocation has dropped from 9 per cent to 7 per cent over the past several quarters. However, after talking to many HNW individuals, I'm starting to see this more as a short-term tactical move rather than a long-term strategic shift. As HNW individuals take profits in public equities, I expect the allocation to hedge funds will return to a "normal" level over the next few quarters.

In other words, the long-term commitment to hedge funds hasn't really changed. The vast majority of HNW individuals I've met (easily north of 80 per cent) include hedge funds in their portfolio, although most see this allocation as part of a larger "alternative assets" bucket, which includes private equity, commodities and certain kinds of real estate as well.

With interest rates so low and valuations stretched in credit markets, hedge funds may benefit from a larger slice of total future asset allocations. In particular, we could see some long-only credit assets gradually move into alternative options, such as long/short hedge funds.

HNW individuals continue to see hedge funds as a potential way to protect against downside risk, and an intriguing way to make money in times of increased volatility. Perhaps unsurprisingly, there is much less of an appetite for the hyper-aggressive, global-macro style of hedge fund that was all the rage prior to the financial crisis of 2007-2008.

To the public eye, hedge funds are associated with spectacular returns, phenomenal collapses, and Hollywood style scripts. In reality, true hedge funds manage their market exposure at around 5 per cent, in either the long or short direction, and typically have neutral strategies in bonds, equities and derivative products. This makes them great candidates to help manage risk.

To see why, consider the following chart (link – page 18), which details the performance of two model portfolios. The first a traditional 60/40 portfolio, split between equities and bonds. This has been the "go-to" allocation for years; the one touted as the allocation that suits most investors most of the time.

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The second line is a 33/33/33 split between equities, bonds and hedge funds. Keep in mind that such a portfolio is probably skewed a little more to hedge funds than the typical HNW portfolio, but it gives you an idea of what an allocation to "alternatives" can do to overall portfolio returns.

I think this is a pretty good argument for moving away from the traditional 60/40 portfolio. Hedge funds and alternative assets are a plausible place for some of that allocation, particularly market neutral and long/short funds, which offer downside protection in a way that a long-only equity/bonds strategy often doesn't. With the proliferation of ETFs operating in the alternative space, it's now relatively easy to implement such an allocation, even for investors of more modest means.

That being said, does everyone need an allocation as high as 33 per cent? Probably not. For the average investor still in "wealth accumulation" mode, I think an allocation of 10-15 per cent of the total portfolio to the broader alternative asset space (of which hedge funds would comprise a significant chunk) might be appropriate – of course, subject to a review of your particular situation.

The bigger your portfolio, the more you've shifted from wealth accumulation to wealth preservation , and the bigger that allocation might be; high-net-worth individuals might consider between 15 per cent and 33 per cent.

Thane Stenner is founder of Stenner Investment Partners within Richardson GMP Ltd., as well as Portfolio Manager and Director, Wealth Management. Thane is also Managing Director for TIGER 21 Canada ( He is the bestselling author of ´True Wealth: an expert guide for high-net-worth individuals (and their advisors)'. ( ( The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates.Richardson GMP Limited, Member Canadian Investor Protection Fund.

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