Fund of hedge funds series, part 3-1: monitoring and rebalancing
Active monitoring and regular portfolio rebalancing are crucial to maintaining a hedge fund's desired risk-return profile. This involves staying informed about market changes, performance metrics, and any shifts in the underlying hedge funds.
Since this part is very essential and important, I will do it in two parts.
Active monitoring and regular portfolio rebalancing are crucial to maintaining a hedge fund's desired risk-return profile. This involves staying informed about market changes, performance metrics, and any shifts in the underlying hedge funds. Regularly adjusting allocations is necessary to respond to new opportunities and mitigate emerging risks.
Effective monitoring ensures that the portfolio remains aligned with the investment strategy and objectives. Implementing a disciplined rebalancing process helps capitalize on market movements and manage potential volatility.
Based on market readings, choose between directional strategies with exposure to the market or absolute return strategies with minimal beta towards the markets. For example, if the market is bullish, you might allocate 60% to directional strategies and 40% to absolute return strategies. Conversely, in a bearish market, a 70% allocation to absolute return strategies and 30% to directional strategies might be more prudent.
It's also important to consider the impact of long lock-up periods, as they can make rebalancing more challenging.
Additionally, conducting thorough post-investment due diligence is essential. After investing, meet with the fund manager each quarter to stay informed about the fund's insights, strategy, and operational updates. This helps ensure transparency and allows for timely adjustments based on new information.
Be very alert to any style drift, as it not only indicates that the initial reason for investment in the manager has faded but also means the portfolio allocation thesis may no longer be fitting. Identifying and addressing style drift promptly helps maintain the integrity and effectiveness of the overall investment strategy.
For example, in our Fund of Hedge funds, AMP, we are unforgiving about any style drift. If that happens, firing the manager is not a remote option unless there is a very strong reason that justifies the drift, and it is not permanent.
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Eighteen years in investment management, M&A and financial technology. A CFA Charterholder, he leads investment analysis, valuation and fund structuring across Significa's advisory and investment practices, and teaches valuation and fund structures in the CVC Builder curriculum. Concurrently Chief M&A and Growth Officer at AlternativeSoft in London; co-founder of MarkeScope, which developed the first stock-screening solution to incorporate risk measures. Treasurer of CFA Society Egypt; BSc Electrical, Electronics and Communications Engineering, Cairo University.