(International Adviser) -- UBS Wealth Management is recommending clients allocate up to 20% of their assets to hedge funds as a diversifier, especially in an environment where interest rates and volatility are increasing, according to the firm’s executives.
“We are recommending an allocation from 14% to 20%, which I would say, compared to others, is high,” Adrian Zuercher, UBS Wealth’s Hong Kong-based managing director and head of asset allocation for Asia Pacific, said at a media briefing yesterday in Hong Kong.
Zuercher added that the “more standard solution” or balanced portfolio would have around 18%-20% allocated to hedge funds, while the more defensive portfolios would have 14% in such products.
The firm’s recommended allocation is indeed big compared to other private banks. For example, Bank of Singapore is recommending a 14% allocation to alternatives, which includes hedge funds, in a balanced portfolio, while BNP Wealth Management is recommending around 5%-10%.
Hedge reduces volatility?
The recommended allocation to hedge funds is for a client’s core and tactical portfolios, noted Gunther Jost, head of hedge funds for Asia-Pacific.
“We build diversified hedge fund portfolios for our clients and we look at it from a core-satellite approach, where we have allocations to a diversified core, and we would add some satellites around that,” Jost explained.
“We want to have hedge funds in the portfolio in an environment where potentially the correlation of equities and bonds go up, and hedge funds help stabilise the portfolio and can behave independently,” Jost said.
Fund managers, such as Neuberger Berman, have also warned investors about the increasing correlation between equities and bonds.
Jost noted that UBS Wealth sees hedge funds as a diversifier and not as a return enhancer. Other private banks, such as Citi, have also noted the role of hedge funds in diversification.
According to Jost, adding hedge funds helps reduce the overall volatility of a portfolio. For example, if clients were to add 20% in hedge funds to a pure equities portfolios, the overall portfolio volatility is reduced, and at the same time, returns are likely to go up. “The same applies to a balanced portfolio and a fixed income portfolio,” he said.
However, hedge funds have underperformed the MSCI World Index and the S&P 500 since 2012 (chart below). The underperformance, plus high fees (they typically charge 2-and-20 like a private equity fund) and poor transparency have caused investors to sour on them.
Jost counters that hedge funds tend to do well in a rising rate environment. Year-to-April, the HFRI Fund Weighted Composite returned 0.41, slightly beating the MSCI AC World (0.16%) and the S&P 500 (-0.96%), according to FE data.
“The reason is in such environments, there is higher volatility, higher dispersions, which is a good environment for stock pickers and hedge funds,” he said.
Jost recommends that investors should have a diversified portfolio of hedge funds and not just focus on one strategy. For example, long-short equity hedge fund strategies had the best performance in the asset class during the period of 1992-2015. However, they also have the highest volatility and maximum drawdowns.
“If you combine different strategies, you come up with a diversified portfolio, which is the best way of investing into hedge funds, because each style performs differently depending on the market environment.”
Low take up Hedge funds still account for a small percentage of Asian investors’ assets. Arnaud Tellier, Singapore-based head of investment services for Asia-Pacific at BNP Paribas Wealth Management, said that clients are under-allocated to the asset class and below the recommended 5%-10% allocation.
At UBS Wealth, invested assets in hedge funds from Asia-Pacific clients has grown 60% over the past three years, according to Jost. However, this still represent only a single-digit percentage in the firm’s overall Asia-Pacific AUM of CHF 373bn ($375bn) as of the end of 2017.
“The penetration of hedge funds is still very small,” Zuercher said, adding that a lot of the firm’s clients still have no hedge funds in their portfolios.
“We do a lot of events where we educate our clients and give them the chance to meet the managers directly, to give them a better understanding of how the strategies work,” Jost added.