How retail investors can gain exposure to hedge funds

How retail investors can gain exposure to hedge funds

NAV TL;DR

If you don’t have time to read through the whole article, you can check out our short version below.

  • Hedge fund ETFs aim to mimic the investment strategies of hedge funds.
  • They offer retail investors the opportunity to gain exposure to an asset class usually reserved for institutional and high net-worth investors.
  • As with all investments, it is important to do your due diligence by understanding the risks involved as well as building up your knowledge of hedge fund strategies.

Hedge funds are managed pooled investment funds that use a variety of sophisticated strategies to deliver better than market average returns for investors. The strategies used by hedge funds can include the use of short selling, leverage, and derivatives (e.g futures, options), among others.

This contrasts with most unit trusts and exchange-traded funds (ETFs), which tend to have strategies that invest in only stocks and bonds.

As the strategies used by hedge funds to generate gains tend to be complex and associated with higher risk, they are limited to institutional investors and high net worth individuals.

That said, in recent years, there has been an increase in ETFs which aim to mimic the investment strategies of hedge funds. As ETFs trade on public exchanges like stocks and bonds, it is more accessible for retail investors to gain exposure to this alternative asset class.

But like all investments, there are factors to consider when adding them to your investment portfolio as they come with their own set of pros and cons.

Before getting a better understanding of hedge fund ETFs, it helps to recap what ETFs are.

ETFs are pooled investment funds that allow you to build diversity in your investment portfolio with relative ease as they track benchmark indices like the S&P 500 or the Straits Times Index (STI).

This allows you to capture broad-based performance of a particular market. An ETF can also mitigate the level of volatility (to a certain extent) if some stocks within an ETF fall.

intro to hedge funds

What is a hedge fund?

Hedge fund ETFs aim to replicate the trading activity and investment strategy of a hedge fund to creating returns similar to those of investors of a regular hedge fund.

Some strategies that hedge fund ETFs can replicate include:

  • Long/short equity
  • Merger arbitrage
  • Global macro
  • Event-driven
  • Distressed debt
  • Multi-strategy

This can be done in two ways:

intro to hedge funds

Pros of hedge fund ETFs

Hedge fund ETFs provide accessibility for retail investors, which otherwise, were only available to institutional investors and high net worth individuals.

Hedge funds often require high minimum investment sums but with an ETF, it is possible to gain exposure to hedge funds for much less. As such, hedge fund ETFs make it possible for a wider number of investors to realize gains from hedge fund strategies.

Given hedge funds are riskier investments than financial instruments using traditional strategies, there is the possibility of generating better-than-average returns for your portfolio.

The other upside of hedge fund ETFs is the potential to generate above-average returns in your portfolio if those strategies pay off.

You can find hedge fund ETFs offered through online brokerage, including DBS Vickers.

intro to hedge funds

Cons of hedge fund ETFs

As with all investments, there are cons to investing in hedge fund ETFs.

While there is the potential that the hedge fund strategies you are invested in can result in large gains, hedge fund ETFs are riskier and price movements could be more volatile compared to traditional index ETFs or unit trusts. This also means that your losses could be greater if the hedge fund strategy the ETF invests in does not work out.

As such, it is prudent to limit the portion of your portfolio allocated to hedge fund ETFs.

Compared to traditional index ETFs, hedge fund ETFs do cost more. Much of the reason behind this is that hedge funds have active management strategies, which in turn, results in hedge fund ETFs having more active management than traditional index ETFs.

In sum

Hedge fund ETFs can be an investment alternative for retail investors to consider but it is important that you consider the risks and costs of involved as well as whether they would make worthwhile investments to meet your financial goals.

When selecting which hedge fund ETFs to invest in, you should first take the time to understand the various strategies that hedge funds employ. Only then, will you be able to better considerations regarding which strategies or individual ETFs to invest in.

Also, consider the fund’s track record and performance as well as its fees to help you narrow down the list.

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Disclaimers and Important Notice

This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.

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