Cheap access to hedge funds sounds too good to be true. More often than not, you will have to pay a premium to gain exposure to this sector. But there are plenty of investment trusts that invest in hedge funds and are sitting on big discounts to their net asset value.
The term 'hedge fund' has a very broad meaning but, generally, hedge funds aspire to generate absolute returns irrespective of the market environment. However, despite some enjoying a roaring success in recent years, 'aspiring' is as much as others have achieved, while a number, such as Amaranth in 2006 and Peloton Master Fund in 2008, have spectacularly blown up.
In 2008 when the credit crisis really kicked off, the average hedge fund lost around 19 per cent for investors - making the phrase 'absolute returns' seem more like an absolute joke.
But the allure of hedge funds remains stubborn regardless of bad news, and investors continue to look beyond traditional bonds and equities for income - if nothing else - at least to try to diversify their portfolios.
Direct investment in this asset class requires hundreds of thousands of pounds upfront, but there are alternative, cheaper ways to gain access to it.
At the very bottom of the bargain bin lie a small but growing number of exchange traded funds (ETFs) with the cheapest exposure to hedge funds you can buy, with total expense ratios beneath 1 per cent, and some as low as 0.25 per cent. Analysts are sceptical - with most of them firm in the belief this approach doesn't suit private clients' needs.
For starters, the counterparty risk involved is enough to make most of them turn their noses up, despite the low fees. Elizabeth Savage, an analyst at Rathbones, refuses to recommend ETFs to private clients as a way to get hedge funds exposure for this very reason.
She also says investing in alpha hedge funds through beta ETFs doesn't work because the two strategies are conflicting. "The reason why ETFs can be good is because you can trade tactically and quickly - but hedge funds are more of a long-term investment. It just doesn't work because it's synthetic," she argues.
But supporters of the strategy maintain it is a cheap way to access the asset class and an investable benchmark for weighing up hedge fund manager's strategies.
Another, more popular way of getting to hedge funds is through investment trusts that have exposure to the sector. Many of these are trading at big discounts to their net asset values, meaning investors have an opportunity to go bargain-hunting in the sector.
Most of these investment trusts have higher charges than ETFs, but Alex Amos, partner in the funds team at law firm MacFarlanes, points out these are the only way to access most hedge funds - which are often closed to new investors.
Henry Freeman, head of research at Investec, also prefers investment trusts as a vehicle for gaining exposure to hedge funds because of this. He cites highly regarded hedge funds run by Brevan Howard and Third Point as examples of attractive investment vehicles you can only gain exposure to this way. But he warns: "do your homework or don't bother", to avoid getting a nasty surprise you weren't expecting if you don't fully understand the risks involved.
But hedge fund investment trusts can come with a hefty price tag relative to other funds with equivalent returns. Ten of the top performing 29 AIC UK funds have total expense ratios exceeding 2 per cent, with some approaching and even exceeding 3 per cent.
A third option for hedge fund exposure lies in the myriad of open-ended funds launched in recent years, which seek to make use of the wider investment powers available under UCITS 3 rules (European laws introduced in 2001) to employ hedge fund-like strategies. A number of these 'absolute return funds' have enjoyed a healthy level of success in recent years. However, it's vital to be "super selective" when investing in absolute return funds warns Jason Hollands, managing director of business development and communications at Bestinvest.
"The industry has sucked in a lot of new entrants over the last decade, which has probably diluted the overall talent quality and there has been a tendency for traditional asset managers to allow some of their managers to 'have a go' at running these funds, sometimes to stop them leaving to the pure hedge fund world," he explains.
Mr Hollands is wary of the disappointing performance of many of them, as well as fee charging structures loaded in favour of the managers - a common bone of contention among investors.
And also he warns of an extra complication with the sector in general. Unlike the world of conventional funds, which he describes as "littered with pedestrian performers", he says the hedge fund world is more "Darwinian" - quicker to close down funds that fail, making it hard to get a true picture of success, since funds that flop disappear in a flash.
So the over-arching message when hunting for hedge funds is don't buy unless you know exactly what you're letting yourself in for. And be wary that a watered-down cost could leave you with a watered-down return.
There are, however, some reasonably priced investment trusts and open-ended funds with exposure to hedge funds and absolute return strategies with sturdy track records which are well worth a look if you're planning to go down this road to diversify your portfolio. So swot up - and value for money hedge fund exposure could be well within your reach.
