AIMA and CAIA Divide Hedge Funds Into Substitutes and Diversifiers

AIMA CAIA Hedge Funds Substitutes Diversifiers

Mainstream media outlets still tend to portray hedge funds and hedge-fund strategies as high risk / high reward options for the ultra-rich. We know, however, that hedge funds are used primarily as “hedges” – to diversify portfolio returns – and that many hedge-fund strategies have lower volatility than long-only portfolios of stocks.

Even more importantly, hedge funds and the strategies they’ve historically pursued can have low correlation to traditional assets like stocks and bonds. Thus, even though a strategy could be more volatile than stocks or bonds on its own, the low correlation of the style to traditional assets could still lower the total volatility when added to a portfolio of traditional assets.

The Dual Role of Hedge Funds

This dual role of hedge funds and hedge-fund strategies has caused the Alternative Investment Management Association (“AIMA”) and the Chartered Alternative Investment Analyst Association (“CAIA Association”) to break hedge funds into clusters of “substitute” and “diversifier” strategies in their newly published white paper: Portfolio Transformers: Examining the Role of Hedge Funds as Substitutes and Diversifiers in an Investor Portfolio.

“This new paper underlines the heterogeneity of hedge funds today,” said AIMA CEO Jack Inglis, in a recent announcement regarding the white paper’s publication. “For every type of fund, there are just as many solutions to investors’ particular requirements. The paper also makes it clear that the old distinctions that have underpinned portfolio construction for the last 25 years are disappearing.”

Substitutes and Diversifiers

AIMA and the CAIA Association consider the following as potential substitutes that could replace a long-only allocation to stocks, bonds and other asset classes:

  • Long/short equity funds
  • Long/short credit funds
  • Event driven funds
  • Fixed income arbitrage funds
  • Convertible arbitrage funds
  • Emerging markets funds

While the remaining strategies tend to work better as overall portfolio diversifiers:

  • Global macro funds
  • Managed futures funds/CTAs
  • Equity market-neutral funds

“Pensions, endowments, foundations, insurers and family offices are different entities, with different challenges and divergent investment aims,” said Mr. Inglis. “But what many of them have in common is a wish to see hedge funds as another method of investing in equities, bonds and other asset classes, rather than as a separate asset class. This new thinking promises to transform the risk and return profiles of institutional investor portfolios.”

Different types of institutions – like pensions, endowments, etc. – have different mandates, and thus they should have different portfolios in pursuit of those mandates. The AIMA / CAIA white paper explores how “substitute” and “diversifier” strategies can be employed within the context of these real-world investment objectives.

White Paper Highlights

After beginning with a foreword by Acadia Capital CIO Mark Anson and a discussion of hedge fund strategies and different investor mandates, the white paper rolls into an analysis of using hedge funds with a traditional portfolio, and concludes with appendices for Cluster Analysis and Risk and Correlation. The objective of the paper is to educate hedge-fund and alternative investors on how the different strategies can help them meet their particular investment mandates.

“Education is our only product and we are delighted to partner with AIMA on this latest paper,” said CAIA Association CEO William J. Kelly. “Diversification across multiple asset classes and uncorrelated sources of beta has never been more important, as global equity prices hover near fair value and interest rates remain at or close to zero. Education and informed awareness of any potential solution must be part of this investment process and it is our hope that these papers will continue to add to this understanding.”

For more information, download a pdf copy of the white paper.


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