November 24, 2005

Hedge Funds: Catching up but still a long way to go

A large section of the investor community believes that hedge funds are a riskier proposition as compared with mutual funds. Most mutual fund managers seek insights into the performance of hedge funds prior to allocating assets to hedge fund strategies.

However, it is to be noted that the investment portfolio managers are set to expand their scope of operation. As reflected by the robust growth in investments into hedge funds over last three years, it is clear that even mutual funds managers are studying the proposition of allocating a portion of the funds they manage to the hedge fund pool.

Many pension funds and endowments scheme managers are boosting their exposure to hedge funds. In the US, hedge funds are increasingly being considered in the portfolio selection of many local county and state employee funds.

Despite a favorable trend, investors are extra cautious after the multi million-dollar debacle involving Bayou fund. Investors prefer mutual funds over hedge funds, due to lack of transparency into the working of hedge funds. In an attempt to improve investor confidence in hedge funds, a comprehensive report was drafted tracking performance of various hedge funds against benchmark index such as S&P 500, and NASDAQ.

The report offers in-depth information on individual hedge fund strategies. What came out was the potential portfolio diversification, which could be achieved for a mutual fund portfolio by allocation of optimal weights to hedge funds strategies. The report also listed some of the best performing hedge funds of last five years. Majority of the hedge fund strategies carry a negative correlation with the S&P 500 and the NASDAQ 100. Thus, diversifying the portfolio by allocating assets to hedge fund strategies is likely to reduce the volatility of a mutual fund benchmarked to the two indexes. Overall, for a retail investor, hedge funds are far from a popular investment destination. But the scene is changing with increasing exposure towards hedge funds.

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