CHICAGO (HedgeWorld.com)--Hedge fund returns have been hit or miss lately--and funds of funds are no exception--but investors don't necessarily have to ramp up leverage to boost performance, according to Mercer Investment Consulting.
Mercer consultants predict that in 2006 superior hedge fund performance will still be hard to come by. Investors eager to stay out of heavy traffic after being whomped by bad investment decisions are better off spending more time on operational due diligence, Mercer officials concluded in a recently released research paper on general hedge fund trends.
Mercer, which provides consulting services to public and corporate pension funds, is advocating the use of "focused" funds of funds to augment the return streams of broadly diversified funds of hedge funds.
Funds of funds that invest only in market neutral strategies or long/short equity are becoming more common, and equity-focused funds of funds in particular make a great equity substitute within an investor's overall investment portfolio, Mercer analysts wrote.
These strategic funds of funds can offer equity-like returns with less volatility, while differing in terms of equity market correlation. Still, the focused portfolio offers the benefits of manager diversification and additional alpha, Mercer said.
Other focused approaches include long-only activist equity funds, fixed-income relative value offerings, emerging managers and tactical trading strategies.
"This specialized strategy can serve either as a complement to a broadly diversified strategy as part of a portable alpha program," said Jeff Gabrione, a research consultant within Mercer's manager research division, in a statement. Portable alpha is a process that separates portfolios that derive returns from manager skill from those strategies that make gains mostly because of overall market moves.
Still he warns that investors must be comfortable with a manager's expertise in the specialty area and also be aware of a focused fund's capacity constraints.