Trump’s initial tariff announcement sent shockwaves through the world economy, sparking a dramatic selloff across asset classes. On a scale not seen since the early days of the pandemic, hedge fund managers faced massive margin calls from Wall Street banks, demanding additional collateral from their hedge fund clients to cover potential losses.
Hedge funds reacted by rapidly increasing their short positions in order to lower net exposure. The US president’s subsequent announcement of a 90-day pause on tariffs – with the very notable exception of China – then led to a squeeze as short sellers sought to limit losses. It was turmoil all around for this more than €4 trillion industry.
Today more than ever, the importance of diversification has never been more obvious. That includes for hedge fund investors.
DIVERSIFICATION MATTERS
Building a robust hedge fund portfolio requires a mix of strategies and geographies to mitigate risk and improve returns. By diversifying across various strategies – such as long-short equity, relative value, global macro and event-driven – investors can reduce their exposure to any single market event or economic shock. As economic cycles and market dynamics can vary across regions, geographic diversification adds an additional layer of protection.
Today more than ever, the importance of diversification has never been more obvious. That includes for hedge fund investors.
Another fundamental principle for hedge fund investors is to avoid seeking to time the market. Attempting to do so can lead to poor investment decisions and missed opportunities. Instead, a well-diversified portfolio that includes a balanced mix of hedge fund strategies has the potential to provide consistent returns over the long term.
Recent market events underscore the need for a disciplined approach to hedge fund investing. The sharp declines in asset values and subsequent margin calls highlight the risks associated with leverage and the importance of maintaining adequate liquidity. Hedge funds that are able to manage their leverage and maintain diversified portfolios tend to be better positioned to weather any storm. Selecting managers with the expertise and experience to manage risk effectively is therefore paramount.
Investors must assess not only the track record of hedge fund managers but also their risk management practices, investment philosophy and ability to adapt to changing market conditions. A comprehensive due diligence process can help identify managers who are well-equipped to navigate periods of market stress and deliver consistent returns.
THE DIFFERENCE A YEAR MAKES
2024 was a strong year for hedge funds, where they were able to prove their value in a total portfolio context. On average, hedge funds posted a 9.83% gain for investors in 2024, according to HFRI Fund Weighted Composite Index data, with positive results in equity, macro, event-driven and relative value strategies. Over the same period, total industry assets under management increased by some €364 billion year on year, the largest gains since 2021.
This year, by comparison, hedge fund managers and investors face what is likely to be a period of prolonged uncertainty. Uncertainty may persist for multiple reasons, including because, first and foremost, no one can confidently predict what action Trump will take on tariffs after the current 90-day cooling-off period. Subsequent bilateral negotiations, if they take place, could prove lengthy and implementation extremely complex, especially given exemptions. Further, it remains to be seen how long any such tariffs could be in effect.
A FINE BALANCE
As part of a diversified portfolio, hedge funds have the potential to support higher risk-adjusted returns, reduce volatility and dampen severe drawdowns. Depending on global economic and market conditions over the rest of this year, differing hedge fund strategies may be appropriate to counter the volatility of traditional asset classes.
As part of a diversified portfolio, hedge funds have the potential to support higher risk-adjusted returns, reduce volatility and dampen severe drawdowns.
Overall and especially in a period when attempting to time the market will be even more difficult than usual, a well-constructed hedge fund portfolio approach should provide far greater diversification benefits than selecting single funds or strategies. That said, if funding becomes more constrained or market dislocations persist, overall strategy performance could deteriorate, triggering deleveraging.
As we navigate what promises to be a challenging 2025, the ability to adapt to changing conditions and identify unique investment opportunities will remain crucial for hedge funds. As always, a disciplined approach – grounded in due diligence and diversification – remains key to navigating future challenges and achieving sustainable returns.