Multi-Strategy Hedge Funds Strive to Navigate Market Volatility

A smooth sea never made a skilled sailor, and markets have been anything but smooth as of late. Contributing to the rough seas are rising interest rates, geopolitical tensions, record inflation, and supply chain and energy crises. With these factors affecting markets today, a well-balanced approach to investing, helmed by seasoned market veterans, may help to right the ship and mitigate portfolio volatility. As volatility has found its way back to markets, Institutional Investor notes that hedge funds have found their way back to being in vogue with allocators. But not all hedge fund strategies are created equal, as investors have indicated that there is a particular strategy more attractive than others at this point: multi-strategy hedge funds, which utilize multiple portfolio management teams to allocate capital. There is strength in numbers, and in rough seas, the more skilled sailors one has on their ship, the better their chances of weathering the storm.

As we describe in our piece Multi-Strategy Hedge Funds Explained, these types of funds combine a variety of generally uncorrelated investment strategies with the goal of delivering a less volatile return stream to investors. The strategies are executed by dedicated portfolio managers (PMs) and may span a full spectrum of markets. Multi-strategy funds may operate under a single manager model, or a multi-manager model: in a single manager model, firm management will be more involved in individual security selection, whereas in a multi-manager model a PM will typically have total discretion within their defined investment universe. In 2021, Multi-strategy funds reigned supreme, reportedly capturing the majority of fresh capital flowing into the hedge fund industry. According to eVestment, multi-strategy funds saw net inflows of approximately $21 billion in 2021, while the rest of the industry experienced combined net outflows of about $7 billion. This stark contrast highlights investor favorability towards this particular strategy. After a strong fundraising year, the multi-strategy approach was the second-largest hedge fund strategy in terms of assets under management, reaching nearly $630 billion.

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Image source: Bloomberg
eVestment

So why are so many investors choosing multi-strategy hedge funds over many other strategies within the hedge fund universe? According to Bloomberg, the cause of these hedge funds’ rise is consistent performance during periods of market chaos. Rather than relying on a single star stock-picker, multi-strategy hedge funds aggregate large pools of capital and attempt to efficiently allocate those funds to an army of traders across various strategies – all under one roof with rigorous risk parameters. The ability to have this diversification of strategy within one hedge fund relationship can be especially attractive to investors who lack the resources to adequately screen and closely track each individual hedge fund manager’s doings.

Source: HFM-Aima

And it is not just the why behind the consistency, but also the how. Multi-strategy hedge funds can be nimble and allocate capital to teams with a high degree of precision. At any given time, teams with a favorable opportunity set who perform are often rewarded with further capital support. Conversely, due to multi-strategy funds’ low tolerance for underperformance, teams utilizing unfavorable strategies at a given time can see asset allocations diminish. Bloomberg continues, “With individual managers less visible to clients, those who start losing in high single digits or overextend their risk can have their assets cut at best, and at worst be fired on the spot.”

Talent is another major contributor to the consistency of these multi-manager multi-strategy hedge funds. Even with a rigorous emphasis on performance, it is still easy for these major platform funds to attract top talent to their programs. While many top traders wish to begin their own funds and run their own business, they recognize the benefit of joining a firm and having more capital to work with almost instantly. According to Andrew Beer, founder of Dynamic Beta Investments, “Joining a multi-strat on Monday and having $500 million to punt around on Tuesday is a [...] lot more appealing than scrounging for $50 million of seed capital to start your own firm.

We have written about drawbacks to multi-strategy hedge funds, including the complexity in managing the risk of the fund’s overall portfolio. When operating a multi-manager model, PM teams are typically siloed to their respective strategies which can make it difficult to attribute the impact of each team to the overall portfolio and potential overlaps in individual teams’ portfolios. Firms will try to mitigate this risk by having a dedicated risk management team that monitors the correlation of underlying portfolios and review if the aggregated portfolio is still operating within the fund’s stated parameters.

Multi-Strategy Hedge Funds Explained

Another risk that is unique to multi-strategy is their returns in short-term time horizons when compared to some single strategy hedge funds. According to Eurekahedge, diversification of strategies can water down returns of particular strategies that have performed well in a short period of time. Investors should benefit from this diversification over a longer time horizon, as the consistency of multi-strategy hedge funds should prove their worth by delivering returns with lower volatility and higher risk-adjusted returns than their single-strategy contemporaries.

Global markets are looking pretty rough lately. From geopolitical conflict to macro issues to stretched valuations, the outlook looks rather opaque. While many hedge fund strategies are designed to be safer bets than traditional equities and provide portfolio protection amidst market volatility, there are those strategies that stand out in their ability to handle the turmoil. With built-in diversification benefits, a multi-strategy hedge fund with proper risk management protocols can help provide consistent, lower-correlated returns over time. The strength in numbers concept of multi-strategy hedge funds may well prove itself again during this storm. As told by last year’s record fundraises, many investors have already indicated their desire to partner with institutional multi-strategy hedge funds and navigate with multiple skilled sailors. You may not wish to get caught in a storm without them.

Sources:
Institutional Investor, February 2022. “Hedge Funds Are Starting to Win Over Allocators Once Again.”
Bloomberg, January 2022. “An Army of Faceless Suits Is Taking Over the $4 Trillion Hedge Fund World.”
eVestment, January 2022. “Hedge fund industry ends 2021 at $3.63T, highest AUM level on record.”
Crystal Capital Partners, October 2021. “Multi-Strategy Hedge Funds Explained.”
HFM-AIMA, 2021. “Investor Intentions H2 2021.”
Eurekahedge, May 2004. “Multi-Strategy Hedge Funds – Strategy Outline.”