Thomas Schneeweis on 9 things to look at before investing in hedge funds

Eminent fund manager Thomas Schneeweis says focusing on past performance is the first and biggest mistake investors make when it comes to asset allocation.

According to Schneeweis, investors should be rather focused on risk instead of returns.

“Much of the past, though interesting, may have very little relevance to what we do today,” he said.”

Who is Thomas Schneeweis?
Thomas Schneeweis is the Founding Editor of The Journal of Alternative Investments and is co-founder of the Chartered Alternative Investment Analyst Association.

He has more than 40 years’ experience in investment management. He is Partner and Head of Research at Yes Wealth Management which provides financial advisory as well as risk based asset allocation and Quantitative Investment Technologies.

He has co-authored several books in the area of asset management including The New Science of Asset Allocation: Risk Management in a Multi-Asset World and PostModern Investment: Facts and Fallacies of Growing Wealth in a Multi-Asset World.

Investing in hedge funds
Schneeweis offered several investment tips on what to look at when investors are looking to invest in hedge funds. Let’s look at these tips-

1. Beware of the unknown, beware of hedge funds
Schneeweis says most hedge funds have lower risk than individual stocks or even stock indices as individual stocks have an annual volatility of about 30%.

“The S&P500’s annual volatility is about 15%. Most hedge funds (with the exception of some long bias or global macro hedge funds) have an annual volatility below 15% and even commodity trading advisors (futures and option traders) have annual volatilities close to that of the S&P500,” he wrote in his book.

2. Stocks for the long run
Schneeweis says hedge funds do add benefits to established traditional stock and bond portfolios.

“Most stocks move up together and down together. As a result, in order to diversify, investors need to invest in investment vehicles such as hedge funds which are constructed to be less sensitive to stock market movements,” he says.

3. Just look at the tracks if you want to know the animal.
Schneeweis says some hedge funds maintain that they are not correlated with the stock market when in fact they are merely an equity fund in hedge fund format.

“Test the actual performance of the hedge fund with indices which reflect traditional stock and bond investment, as well as hedge funds which reflect hedge fund performance. Stock and bond indices exist which reflect the performance of equity and fixed income portfolios. Similarly, there are a number of hedge fund indices which offer similar performance tracking for hedge funds,” he says.

4.. Beware the man behind the curtain
Schneeweis says some hedge fund managers maintain that their system is so secret that they cannot tell how it works or why it works.

“When you meet these managers, simply walk away. Never trust a man who will not tell you what is behind the curtain,” he says.

5. When all else fails, manipulate the data
Schneeweis says many hedge fund managers will promote ideas that have no historical record of performance.

“At times this may be okay, but never rely solely on the data. Place your trust in the foundations of the trading idea not in the performance data,” he says.

6. Clothes maketh the man
Schneeweis says as for any investment, one must look behind the size of the firm, the office space and so on, and concentrate on the actual source of the return.

“If the manager cannot tell you why the strategy makes money in less than five sentences, move on,” he says.

7. The Government will protect you
Schneeweis says some investors believe that there is greater government oversight and protection in traditional stocks and bonds than in hedge funds.

“In fact, most hedge funds have to meet regulatory requirements subject to the markets they trade (e.g., register as a CTA if trading in futures and option markets). However, in both traditional and alternative investment, no amount of government oversight can protect you from an incompetent manager or one who wishes to defraud you Caveat Emptor,” he says.

8. One always knows the value of one’s stock portfolio but not one’s hedge fund.
Schneeweis says unfortunately, many stock and bond funds’ net asset value does not reflect its true market value.

“For instance, emerging market prices are often outdated. By contrast, many hedge funds trade in the most liquid markets, such as futures and option markets, or in highly liquid equity markets. In addition, for most large investments daily pricing and evaluation is normal,” he says.

9. Only the wealthy should invest in hedge funds
Schneeweis says traditional assets forms of investment (e.g. mutual funds, structured notes) exist for hedge funds.

“Moreover, new forms of investment are being created which let individuals invest in hedge funds with less than a $10,000 investment,” he says.

(Disclaimer: This article is based on Thomas Schneeweis various interviews and speeches ).

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