One of the biggest frustrations I’ve had over the past few years is hedge fund managers “gating” their investors.  High-net-worth (HNW) investors commit substantial personal capital to these hedge funds with the expectation that the manager will limit the downside and generate greater returns than your typical index-chasing portfolio. 

Unfortunately, during the downturn, not only did they suffer losses, but they went so far as to lock-up the investors’ assets within the funds.  Investors were unable to access their money for an indefinite period of time regardless of circumstances. 

To me this is inexcusable; while I understand investments in private equity and other illiquid strategies have longer-term commitments, it is unconscionable to think a long-short domestic manager should and/or would tie up their investors’ assets.  For this reason, I encourage investors to avoid limited partnerships with gating provisions in place. 

Some good has actually come out of the publicity on gating. The industry has seen the expansion of publicly-traded alternative (hedge fund) mutual funds.  As a portfolio manager of an alternative mutual fund, I am far from impartial, but recently a number of well-respected hedge fund managers have decided to offer their strategies in this liquid, transparent format with daily pricing. 

I would encourage all HNW investors to consider adding exposure to alternatives—but first look at the alternatives offered in a mutual fund format.  Typically, adding a hedged strategy would decrease a portfolio’s overall correlation to the markets and would therefore lower the portfolio’s risk profile and corresponding volatility.  

I would strongly encourage investors to focus on risk-adjusted returns. A tactically-managed hedged strategy may offer the added benefit of providing an asymmetric risk/reward profile. If the hedged strategy is available in a mutual fund format then the risk-adjusted return profile gets even more attractive given the importance of liquidity in calculating risk-adjusted returns.