Are Hedge Funds an “Asset Class?”
I’ve heard people refer to hedge funds as an “asset class,” implying that hedge funds are somehow distinct from other asset classes such as equities or fixed income. I believe that hedge funds are not a separate asset class but rather share similar investment attributes to the underlying assets they invest in.
Anticipate Distinct Outcomes
Regardless of where you come out on the issue, hedge funds are investment vehicles made up of distinct legal terms.
When a US investor buys a hedge fund interest, it’s typically buying a limited partnership interest or, if it’s a US tax-exempt investor, perhaps the interests in an offshore fund entity.
So while the investment attributes of, say, a long-short equity hedge fund may be highly correlated to the equity markets, the contractual terms of a hedge fund reflected in its limited partnership agreement may result in a much different investment outcome to investors based on a manager’s actions versus buying a basket of public equities.
Moreover, even among two or more hedge funds that pursue investment objectives with similar risk/return profiles, investors may experience different investment outcomes from one fund to the next, depending on what fund contractual terms permit mangers do or don’t do in pursuit of its investment program.
The Bottom Line
Be careful about applying labels to hedge fund investing that take into account strictly financial factors but ignore important contractual terms that can have a material impact on an investment outcome.
Lumping hedge funds together that have similar risk/return attributes and expecting similar investment outcomes can lead to disappointment if an investor is not aware of a fund’s contractual terms.