Much of the “herd” behaviour of investment markets and the impact of government regulations and constraints create massive inefficiencies which unconstrained investors (hedge funds and some long term investors) can and do exploit. Opportunities abound across asset classes and between securities and sectors within asset classes, and even more so in non-traditional investments like convertible bonds which have been savagely sold off beyond any conservative calculation of fair value.

Although there is less leverage available to hedge funds there are two things in their favour: First, the opportunities are so great that less leverage (if any) is needed to generate very attractive risk adjusted returns; and second, there are far fewer hedge funds and much less competition in the hedge fund space from investment banks, which should make capturing these inefficiencies much easier for those who have survived. With little transparency into future corporate earnings and the end of the credit crisis difficult to predict, now is not the time to be reducing a portfolio’s diversification.

Hedge fund strategies offer diversification benefits to a portfolio through their low volatility and long term low correlations to existing strategies. Our experience has shown that what have been classified as hedge fund techniques can lessen a balanced fund portfolio’s dependence on one economic scenario – the “perfect world” of improving global growth and stable inflation rates which fuel equity markets. If a less than perfect scenario unfolds, like slowing growth or rising inflation, there is a very real chance that most traditional balanced funds will not achieve performance objectives.

Few would contest that moving away from this dependence would be of great benefit to investors by dampening an investment portfolio’s losses in times of recession . Where To From Here for Investors ? We believe 2009 will be characterised by slowly returning investor confidence in the financial system which will manifest itself in a return of focus on fundamentals. In this environment, active management should thrive and we feel strongly that this is a time when hedge funds will redeem themselves.

But now, as always, we must be judicious in the way we invest. Going forward, investors should be building portfolios which capture some of the advantages of using leverage, short selling and derivatives, but this needs to be executed in a very prudent manner. Derivatives have a very tangible economic value, transferring risk from one party to another. They can be very positive investment tools or very destructive in the wrong hands. For JANA, adhering to some simple principles that are particularly pertinent for investing in hedge funds can mitigate a number of risks:

Join the discussion