Special Report – Hedge Fund Questions and Answers

What makes Hewitt Investment Group's research on alternative investments different?
HIG has approached alternative assets from the perspective of an “informed skeptic.” This approach sets a high standard for any asset class, strategy, or manager in which our clients invest. As a completely independent advisor, HIG never is incentivised to prefer any particular strategy or asset manager. This approach has kept our clients out of the debacles in alternative assets that have victimized many plan sponsors during recent years.

How does Hewitt Investment Group evaluate alternative investments? How is this evaluation different from traditional asset classes?
Our evaluation of alternative asset managers shares many features with our evaluation of traditional managers. However, the alternative assets segment requires a more thorough analysis. In our experience, many evaluators of private equity and hedge funds place too much emphasis on past returns and statistics. We emphasize people and process in our evaluation. We demand that the actual decision-makers have ample incentives and that their interests are aligned with those of limited partners. In evaluating investment processes, we have a thorough understanding of the sources of returns, and do not simply rely on statistics to evaluate success or failure. <Back to Top>

How should I get exposure to private equity?
Structuring a private equity investment program is dependent upon such factors as risk tolerance and plan size. Most small to mid-sized plans are best served by a fund-of-funds ("FoFs"). While FoFs add an extra layer of costs, they also add an extra layer of due diligence and fiduciary responsibility. In addition, FoFs may be less expensive to administer, since direct fund commitments require additional staff, administration, and legal resources. They also help plan sponsors avoid the "80/20 rule" (spending 80% of monitoring and evaluation time on portfolios that account for 20% or less of assets). In the current environment, FoFs also serve as the best way to achieve access to top-tier venture capital funds, which now have demand that far exceed their capacity. Larger plans with established contacts have the scale to manage successful private equity programs, and benefit from the control that they maintain over investment style and their cash flow cycle. <Back to Top>

What are the pros and cons of investing in real estate?
Real estate has proven to be an excellent diversifier of traditional asset portfolios over time. While the return potential of real estate is well below that of private equity, real estate benefits diversified portfolios by dampening volatility. Unfortunately, the illiquidity of real estate mitigates some of the diversification benefits since rebalancing is difficult and sometimes impossible. A well-structured real estate program should balance the cash requirements and outflows to achieve the highest diversification potential. <Back to Top>

What exactly are "hedge funds?"
The term "hedge fund" is used to describe a myriad of strategies. In short, the only commonality among these strategies is that they tend to be private partnerships that manage money for a percentage of profits, and have no benchmark constraints. Some observers think of hedge funds as "total return" vehicles, but this is not always the case. In our experience, the categorizations of hedge funds often are misleading (such as one index group, which classified Long-Term Capital Management as "market neutral"). We categorize hedge funds based on their investment processes, and evaluate funds relative to their true style. HIG has both positive and negative biases of various hedge fund styles. <Back to Top>

What does HIG look for in a hedge fund, or a hedge fund style?
Hedge funds styles that are rated most highly by HIG have three things in common. First, the strategy capitalizes on an identifiable market premium. Second, the premium is economically justified. Finally, the premium is persistent. An example of a strategy that ranks highly by this metric is merger arbitrage. <Back to Top>

Should we be concerned about our hedge fund exposure?
Absolutely. While hedge funds offer plan sponsors some opportunity in a portfolio context, they can be very dangerous as well. Unfortunately, hedge funds are misrepresented regularly by proponents of the strategies. One of the most common mistakes is setting assumptions based on hedge fund "indices." The problems of survivorship and selection biases aside, plan sponsors should recognize that individual hedge funds bear little resemblance to these "indices" in their performance patterns. A hedge fund program must be consistent with its goals both in terms of the strategies in which it is invested, as well as the number of funds that are used. <Back to Top>