Alternatives as an Asset Class, part I


In a previous article on asset allocations I listed Hedge Funds and Alternative Mutual Funds as part of my asset allocation.  These encompass a significant portion of my personal assets and I feel it’s important to discuss these further and explain the why behind these choices I’ve made.

“Alternative Investing” is a fairly new, in-vogue term for investing outside of traditional asset classes, stocks and bonds.  Alternatives usually involve short selling, derivatives, hard assets, investment real estate and hedge funds.  I invest in all of these to some extent, with the sole purpose of having assets that are negatively correlated to the stock market.  I like to be in assets that zig when stocks zag, yet provide capital appreciation.  In today’s article I’ll discuss why I am invested in a hedge fund (over the upcoming weekend I’ll provide part II which will delve into “alternative” mutual funds).

Hedge funds began in 1949.  An investor named Alfred Winslow Jones formed the first hedge fund which employed both leverage and short-selling.  Over the ensuing 34 year period his fund suffered only 3 losing years (in contrast, the S&P 500 suffered 9 losing years over the same period).  By design hedge funds provide accredited investors arcane means in which to earn profits from the financial markets.  They have the flexibility to employ short-selling and market neutral strategies, merger arbitrage and derivatives trading.  They can invest in private equity, they can employ vast amounts of leverage, they can hold very concentrated positions and they can invest in stocks, currencies and the credit markets to name a few.  Also note that hedge funds are structured as limited partnerships and issue a K-1 (versus a 1099) as tax time.

In this era of passive, low fee index investing (don’t forget rob-advisors!), the hedge fund industry has been the recipient of much controversy.  the funds are known as 2 and 20 ,  Meaning they normally charge a 2% management fee as well as 20% of the profits they make (see link for more details)   Regardless of these controversial fees I decided in invest a portion of my money in two separate hedge funds.   I’ll touch on one of them….

Not quite a year ago I discovered a local hedge fund whose office is literally 7 miles from my home.  I contacted the fund manager and we set up an afternoon meeting and I was pleasantly surprised that he was delightful.  Long story short, in the vast universe of hedge funds, this is one I was most impressed with.  The fund’s performance was outstanding, and with far less risk than the market.  Thru February, 2018 since inception (August, 2002) the fund has returned 427% versus the S&P 500’s return of 309%, NET OF FEES!  In 2008 the fund was -6.9% versus the S&P’s -37%, yet in 2009 (the recovery year), the fund in question outperformed again.  The fund was +27.8% versus the S&P’s +26.5%.  All in all, I am a long term investor in this long/short equity hedge fund for the following reason; superior outperformance at far lower risk.  I was very lucky to find such a gem.  Investment in this particular hedge fund doesn’t mean I am uncorrelated with the stock indices.  The fund is usually between 40-80% net long contingent on a number of factors, including the ability to find and purchase stocks in companies at reasonable valuations.  Currently the fund is positioned 73% net long, with 25 Long positions and 2 Short positions.

Readers may be intrigued with hedge funds just as I have always been.  However, some readers may not be accredited investors and therefore do not have the means by which to invest in a bona fide hedge fund.  In my forthcoming article I will provide readers with a list of the liquid alternative mutual funds that I’m invested in.    The whole reason I am invested in hedge funds and alternatives is because I am far less interested in capturing the final 5-10% of the Bull Cycle than I am avoiding the next 25% of downside in a probable Bear Market.



3 thoughts on “Alternatives as an Asset Class, part I

Leave a Reply