Charities hoping to protect their investment income against the current volatility of the stock market should invest part of their portfolio in hedge funds, according to Baring Asset Management.
Hedge funds - which use a variety of non-traditional investment methods, often "hedging
against downturns in the market to deliver positive returns under all market conditions - have widely been perceived as risky.
This reputation was encouraged by the collapse of major US hedge fund Long Term Asset Management in 1998, which sparked a global sell-off of shares.
But according to Andrew Raisman, assistant director of Baring Asset Management's charities business, they can help reduce risk in charity portfolios and provide a reliable source of investment income.
"Investors increasingly realise that hedge funds are not necessarily high-risk investments, but can be used as a stabilising element within a portfolio giving absolute returns whatever equity and bond markets are doing. Introducing an exposure to hedge funds can actually reduce risk,
The Trustee Act 2000 permits trustees to consider a wider selection of asset classes than the traditional domains of equities and bonds.
Raisman said the poor performance of equities and bonds over the past two years signalled the beginning of long-term volatility.
"We don't expect a return to the heady days of the early 90s. In the next 20 years, it will be more difficult to get strong returns. There will be negative years and it will be more volatile. We are predicting average returns of 7 per cent for UK equities."
By contrast, Baring's hedge funds produced a positive return over the past two years, when bonds and equities were negative, Raisman said.
He advised charities against directly investing in individual hedge funds.
Funds based on particular strategies could do extremely well in some years and suffer in others, he said.
Instead, charities should invest in a fund of hedge funds. "These smooth out the performance of individual hedge funds and give modest but predictable returns,
he said. Baring's is recommending a 5 per cent allocation to hedge funds in a balanced portfolio.
Raisman conceded that hedge funds could offer lower returns in future than at present because they are in vogue. "But we still find the sector sufficiently attractive to warrant a smaller allocation to hedge funds."
He added that two of Baring's charity clients had already invested in hedge funds and more were intending to do so.
- Hedge fund is a generic term for funds that use non-traditional investment strategies to deliver positive returns under all market conditions
- Their performance is not related to that of equities and bonds
- Charities are advised to allocate around 5 per cent of their investment in less risky hedge funds of funds
- The Trustee Act 2000 allows trustees to consider a wider range of asset classes than equities and bonds.