How To Pick The Best Hedge Funds

Reviewed: November 17, 2014
By FinanceWeb

Picking a hedge fund is a great way to improve the portfolio. Investors use hedge funds to diversify, reduce risks, and improve growth. To decide which hedge funds are best, the investor should consider its needs. This assessment can easily take the form of a set of guidelines that point to the investment goals in each category of analysis.

Popular Hedge Funds

Overall the hedge fund industry is growing and increasing the amounts of assets under management. In 2014, it reached a new high of approximately $2.8 Trillion. The number of hedge funds also increased significantly over the previous year’s total. An excellent way to select a hedge fund is to look at the growth over a recent period such as the previous twelve months for which information may be available. Among the 10 top volume hedge funds, previous 12-month growth figures were as high as 34%, with four funds showing asset growth above 20 percent. Hedge funds that show a lot of growth face a distinct challenge, for they must duplicate the same levels of performance at higher investment volumes. For that reason, when considering growth of assets, one might look to the history carefully and see whether the fund has shown it can handle large increases in assets under investment.

Minimum Investments and Term

The amount of money required and the duration before redemption are important factors for every investor. For many, the amount determines whether there will be sufficient diversification. The term is important particularly in rapidly changing markets or, as now, when a low-interest environment might begin to change. The investment amount may not limit large institutional investors, but when seeking diversification, the amount is a factor; the goal is balance and protection against risks.

Profits and Performance

When selecting a hedge fund in order to improve portfolio, one should consider the recent record of the fund for profits. Growth in the previous 12-month period would be a way to select a candidate that could help an investment portfolio to grow. In addition to the basic data on profits and equity growth, one should look at the areas of focus and techniques applied to generate high yields. For example, if the technique involved short sales of foreign bonds in an event driven scenario such as falling oil prices or an international conflict, one can assess the future market impacts.

Managerial Qualities

Management is an important aspect of hedge fund performance. Managers must select investments and decide upon strategies for maximizing profits for investors. Management styles can be highly individualized traits, and managers build on past success. In an increasingly global economy, many investors look for a transition of management strategies such as macro analysis to a global setting. Investors can also look at innovations. For example, the growth in hedge mutual funds that enable mutual funds to use longer terms, leverage, or illiquid investments. This innovation has expanded the potential for actively managed mutual funds to provide consistent high returns over a wider range of market conditions.

Focus

Hedge funds can focus on a particular sector, a specific commodity, or other narrow aspects of the market. These concentrations can be desirable traits particularly if the investor has knowledge or experience in one or more category of investment. However, hedge funds typically do not follow market trends in the ways the traditional investments might. They use aggressive techniques. Investing long in a given area might seem to be a good way to make a profit. However, an aggressive hedge fund might sell short and reap a profit on falling prices before taking a long position for rising prices in an undervalued stock.