Investors participate in hedge funds in hopes of generating superior returns while their investments exhibit low correlations to the traditional equity markets. Hedge fund managers take advantage of every opportunity they can to generate returns. Statistical arbitrage managers constantly look for hidden patterns in the markets to exploit while the convertible arbitrage manager looks for mispricings between the convertible and the underlying stock. This constant search for value and the great latitude to manage the funds, including the use of options, futures and leverage, often results in attractive returns in comparison to the traditional equity and debt markets. Hedge funds strategies are often difficult to understand and in many cases, managers are reluctant to disclose the exact nature of the investment process.
Some hedge funds generate high returns in seemingly benign markets by using extensive leverage.
But as demonstrated in August 1998, leverage can also magnify losses dramatically. Complicated hedging strategies employing options or futures may not work as expected in turbulent markets, resulting in greater than expected losses. At NEPC, we believe that Hedge Funds can add value for certain investors. We make every effort to understand our clients investment objectives, risk tolerances and expectations when an investment program is being developed. Hedge funds can play a role in the investment program by diversifying risk by employing investment strategies that differ from those in the traditional asset classes.