Tiger 21 is a high-net-worth (HNW), peer-to-peer network for investors interested in learning how to be better stewards of their capital, for the benefit of their families, and philanthropic communities.
Every quarter, Tiger 21 publishes reports on how members’ portfolios are allocated to broader market categories. While the sample size is small (about 200 individuals), it can provide a high-level overview of what the wealthy are doing with their money right now.
One of the trends that’s been apparent over the past several quarters is a gradual shift into public equity, a move that has continued since 2010’s fourth quarter. The move has worked out well for HNW investors, as equity markets in North America have recently hit new highs.
Of course, money going into public equity has to come from other assets. One of the asset classes that they’ve been shifting out of is hedge funds – the allocation has dropped from 9% to 7% over the past several quarters.
However, after talking to many HNW individuals, I’m starting to see this more as a short-term tactical move rather than a long-term strategic shift. The long-term commitment to hedge funds hasn’t really changed.
Most HNW individuals I’ve met (easily north of 80%) include hedge funds in their portfolio, although most see this allocation as part of a larger “alternative assets” bucket, which includes private equity, commodities, and certain kinds of real estate as well.
HNW individuals continue to see hedge funds as a good way to protect against downside risk and an intriguing way to make money in times of increased volatility.
Perhaps unsurprisingly, there is much less of an appetite for the hyper-aggressive, global-macro style of hedge fund that was all the rage prior to the 2007-08 financial crisis.
To see why, consider some research done by the Centre for Hedge Fund Research on the performance of two model portfolios.
The first a traditional 60/40 portfolio, split between equities and bonds. This has been the “go-to” allocation for years; the one touted as the allocation that suits most investors most of the time.
The second is a 33/33/33 split between equities, bonds, and hedge funds.
Keep in mind that such a portfolio is skewed more to hedge funds than the typical HNW portfolio, but it gives you an idea of what an allocation to “alternative assets” can do to overall returns.
In back-testing the two portfolios to 1993, the research found that the 33/33/33 portfolio produced returns that were about 9% higher than the conventional 60/40 portfolio, with considerably lower risk (specifically, the Sharpe ratio was 30% higher, and the maximum drawdown was 30% lower).
I think this is a pretty good argument for moving away from the traditional 60/40 portfolio and moving at least a portion of that money into hedge funds and alternative assets – particularly into market neutral and long/short funds, which offer downside protection. With the proliferation of ETFs operating in the alternative space, it’s now relatively easy to implement such an allocation, even for investors of more modest means.
Does everyone need an allocation as high as 33%? Probably not.
For the investor still in “wealth accumulation” mode, I think perhaps an allocation of 10% to 15% to the broader alternative asset space (of which hedge funds would comprise a significant chunk) would be appropriate.
The bigger your portfolio, the more you’ve shifted from wealth accumulation to wealth preservation, the bigger that allocation should be; high-net-worth individuals might consider between 15% and 33%.
