Markets have entered an 'age of anxiety'. I think we are going to see an extended period in which investor sentiment swings between extremes of optimism, anticipating a return to normality, and pessimism, worrying that the recent pandemic will have damaging economic, social, and political after effects that will persist longer than expected.
Second, there are hedge funds and there are hedge funds. Some are very aggressive - and some of those types of hedge funds did outperform - and some are very conservative - they are designed to produce stable returns that are uncorrelated to conventional markets.
The headwinds faced by hedge funds over the past 10 years are giving way to tailwinds in the new cycle.
Strategically, there are at least three specific areas of opportunity that stand out.
First, long/short specialists with expertise in healthcare and biotech are well-positioned to benefit from secular trends as well as Covid-related opportunities in the sector.
Second, strong economic growth in Asia appears to be a durable secular trend, so regional specialists have the opportunity to take advantage of investment opportunities especially in China and India.
Third, ongoing volatility creates trading opportunities, so a well-diversified mix of macro and market neutral strategies has the potential to produce stable, high single-digit returns, which is especially attractive relative to the very low yields on Treasuries.
Hedge funds should be part of a well-diversified portfolio. Over a full market cycle hedge funds can reduce correlation to conventional asset classes, improve downside protection, and provide potential upside.
Recent market dislocations and volatility underscore the need for investments with these characteristics.
Hedge funds' 'edge' versus conventional money managers is their ability to concentrate positions in their highest conviction ideas, express those ideas long and short, and actively manage exposures to dampen volatility and mitigate the downside.
The implication for investors is clear. You can be constructive on the long-term outlook, but it is imperative that you balance this with defensive diversification in the intermediate term via hedge funds.
D. Dixon Boardman is founder and chief executive of Optima Asset Management and vice-chairman of the Forbes Family Trust