If you’re looking for portfolio diversification, hedge funds offer a compelling alternative to traditional investments. Known for their flexibility and sophisticated strategies, hedge funds can provide opportunities unavailable in public markets. However, they also come with unique risks that you should evaluate carefully.

What are hedge funds?

Hedge funds are privately managed investment vehicles that pool capital from accredited investors and use complex strategies to seek high returns. Hedge funds operate with fewer regulatory constraints than mutual funds, giving managers the ability to invest in a variety of asset classes, including stocks, bonds, derivatives, currencies and more.

Hedge funds allow you to redeem capital periodically, often quarterly or annually. As a result, they’re relatively liquid, making them more flexible than other investment vehicles. However, the complex structures of hedge funds often expose them to greater market volatility.

Investment strategies and performance

Hedge funds use a broad range of strategies to generate high short-term returns, including:

  • Long/short equity: a strategy that combines long and short positions in stocks. Long positions are bets that a stock’s value will increase, while short positions are bets that a stock’s value will decrease.
  • Global macro: an approach that bets on currency movements, interest rate changes and other macroeconomic trends.
  • Arbitrage: a strategy that takes advantage of buying an asset and then quickly selling it for a profit.

How can you know if a hedge fund is performing well? You can measure hedge funds against risk-adjusted metrics like the Sharpe ratio, which compares excess return and volatility. Or you can benchmark performance against the HFRI Fund Weighted Composite Index, which gives a general overview of the hedge fund industry’s performance.

Risk and return profiles

While hedge funds offer the potential for high returns, they are also exposed to market risks, which may be amplified by some of the strategies they use. Because hedge funds often employ complex instruments and take concentrated positions, losses can be significant if trades move against them.

On the flip side, hedge funds actively manage risk through diversification and dynamic asset allocation. They also use hedging—hence their name—which involves investing in positions that may help reduce the impact of loss, such as options and futures contracts.

Working with a financial advisor

Hedge funds can enhance portfolio returns and provide valuable diversification. However, they require careful due diligence, regular monitoring, a strong understanding of risk, and a long-term perspective. By working with a seasoned financial advisor, you can determine whether a hedge fund is right for your unique goals and situation.

At a glance

  • As alternative investment vehicles, hedge funds offer the potential for high returns.
  • Hedge funds use a variety of complex strategies to generate short- and medium-term gains.
  • These funds also tend to be vulnerable to market risks.

Work with a UBS Financial Advisor to evaluate all your investment options.

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Disclosure

The information contained in this newsletter is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investing involves risks, and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of UBS Financial Services Inc.

Neither UBS Financial Services Inc. nor its employees (including its financial advisors) provide tax or legal advice. You should consult with your legal counsel and/or your accountant or tax professional regarding the legal or tax implications of a particular suggestion, strategy or investment, including any estate planning strategies, before you invest or implement.

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