Market volatility has widened the opportunity set for hedge fund strategies, which can help reshape portfolio behaviour for greater stability.Getty Images
When the U.S.-Iran conflict turned hot this year, sending oil prices surging and buckling equity markets, Cody Gordon’s client portfolios had a lifeline that escaped many other investors.
The main thing performing on their side was managed futures – the hedging investments that thrived as traditional assets faltered, he says.
“That’s really what you want from these strategies,” says Mr. Gordon, wealth advisor and portfolio manager with Versus Financial at National Bank Financial – Wealth Management in Vancouver.
It’s a moment that captures the conversation around alternative solutions, in general, and hedge funds, in particular.
After a prolonged stretch dominated by equity and broad-market beta, wealth managers are waking up to a more complex macro backdrop. It’s one that includes higher interest rates, persistent inflation, geopolitical shocks and increasingly concentrated market leadership.
In such an environment, hedge funds, long marketed as sources of alpha, are once again coming into greater focus. Now, that focus is split between strategies that can deliver returns while limiting downside outcomes.
“It’s not a return-at-all-costs approach,” says Warren Hastings, director for Scotiabank Wealth Management’s equities global portfolio advisory group. “We start by asking what mix of assets delivers the best risk-adjusted returns for clients. Hedge funds are one tool to help achieve that.”
Rather than chasing outsized gains, he says hedge funds and hedge fund strategies are being used increasingly to reshape the overall behaviour of a portfolio: dampening volatility, reducing drawdowns and, critically, preserving liquidity when it’s needed most.
That focus on resilience is particularly relevant today. Years of ultra-low interest rates and quantitative easing rewarded passive exposures and broad-market participation. No more. Now, dispersion is rising between sectors, regions and individual securities. That creates a wider opportunity set for active strategies.
“When you have volatility and higher interest rates, that provides tremendous opportunities for hedge fund managers who have the necessary skills,” Mr. Gordon says. “But finding that manager is the hardest part.”
The performance gap between top- and bottom-quartile hedge fund managers can be hundreds of basis points, he notes. That’s far wider than broad-market or many actively managed public equity funds and their benchmarks.
“The dispersion is massive. You can’t just allocate to ‘hedge funds’ as a category and expect results,” Mr. Gordon says.
Mr. Hastings echoes that view, describing a rigorous vetting process that evaluates not only performance, but governance, risk management, infrastructure and consistency of returns. Metrics such as Sharpe and Sortino ratios, correlation to broader markets and downside capture all play a role.
Just as important is operational integrity – everything from the presence of independent risk oversight to the number of prime brokers supporting the strategy.
“Turning the theory into practice requires a robust manager selection process,” Mr. Hastings says.
From a portfolio construction standpoint, both advisors emphasize diversification within hedge fund strategies.
A multi-strategy (multi-strat) approach often serves as a core allocation, complemented by market-neutral, long/short equity and credit strategies.
Tactical overlays, such as the kind of commodity-focused managed futures Mr. Gordon has relied on this year, can be layered in selectively.
“We run a core allocation to multi-strat managers and then tilt tactically where it makes sense,” Mr. Gordon says.
While some hedge fund strategies can be used opportunistically, core investments shouldn’t be tinkered with constantly. Mr. Hastings feels that the overall alternatives sleeve of a portfolio should be built for durability across cycles, minimizing the need for frequent adjustments.
Liquidity, while generally much better than in private markets, varies by structure. Mr. Gordon prefers strategies with monthly or quarterly redemption windows, arguing that daily liquidity can constrain a manager’s ability to execute effectively.
Transparency is another concern. “If there’s no sufficient ‘look-through’ into the strategy and holdings, that’s a huge red flag. You need to understand how the fund actually makes money,” Mr. Gordon says.
Ultimately, the growing interest in hedge funds reflects a broader shift in portfolio thinking. Traditional diversification between stocks and bonds has become less reliable as correlations have risen.
At the same time, access to alternative strategies has improved, with more vehicles available to advisors.
The result is a gradual repositioning of hedge funds from optional portfolio “sweeteners” to, in some cases, core components of a diversified allocation.
Still, expectations need to be calibrated. Hedge funds are unlikely to consistently “hit the ball out of the park,” as Mr. Gordon puts it. Their value lies elsewhere, in smoothing the ride, preserving capital and creating optionality when market stress strikes.
In such moments, the appeal of hedge fund strategies can rise sharply. They’re not there to outperform in every market, but to behave differently when it matters most, providing stability when everything else is moving in the same direction.
“That’s the key,” Mr. Gordon says. “If you can minimize the downside and keep the portfolio intact, you give yourself the chance to redeploy into opportunities on the other side.”