We believe hedge funds can potentially reduce risk in an allocation of stocks and bonds
Scatter plot showing annualized risk and return of hedge funds, bonds, U.S. equities, and global equities since 1990. Hedge funds achieved a return just under that of U.S. equities but with much lower risk. As of December 2023, data is as follows–Hedge funds annualized return: 9% and annualized standard deviation: 7%. U.S. bonds annualized return: 5% and annualized standard deviation: 4%. U.S. equities annualized return: 10% and annualized standard deviation: 15%. Global equities annualized return: 8% and annualized standard deviation: 15%.
Scatter plot showing annualized risk and return of allocations including and excluding hedge funds since 1990. The inclusion of hedge funds contributed to higher return and lower risk. As of December 2023, data is as follows–20% U.S. equities 60% bonds 20% Hedge funds annualized return: 7% and annualized standard deviation: 5%. 30% U.S. equities 70% bonds annualized return: 7% and annualized standard deviation: 6%. 40% U.S. equities 40% bonds 20% Hedge funds annualized return: 8% and annualized standard deviation: 8%. 50% U.S. equities 50% bonds annualized return: 8% and annualized standard deviation: 8%. 60% U.S. equities 20% bonds 20% Hedge funds annualized return: 9% and annualized standard deviation: 10%. 70% U.S. equities 30% bonds annualized return: 9% and annualized standard deviation: 11%.
Risks
Asset Class Risk Disclosure
Investing in stocks involves risk and their returns and risk levels can vary depending on prevailing market and economic conditions. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Foreign investing has additional risks including currency, transaction, volatility and political and regulatory uncertainty. Alternative investments, such as hedge funds, are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of the U.S. securities laws. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. While investors may potentially benefit from the ability of hedge funds to potentially improve the risk-reward profiles of their portfolios, the investments themselves can carry significant risks. Hedge funds trade in diverse complex strategies that are affected in different ways and at different times by changing market conditions. Strategies may, at times, be out of market favor for considerable periods which can result in adverse consequences for the investor.
Sources: © 2023 – Morningstar Direct, All Rights Reserved1, and Wells Fargo Investment Institute. Data from January 1, 1990 to December 31, 2023. Bonds = Bloomberg U.S. Aggregate Bond Index. U.S. equities = S&P 500 Index. Global equities = MSCI World Index. Hedge funds = HFRI Fund Weighted Composite Index. For illustrative purposes only. Index returns do not represent investment performance or the results of actual trading. Index returns do not represent investment returns or the results of actual trading nor are they forecasts of expected gains or losses a fund might experience. The Bloomberg U.S. Aggregate Bond Index is a broad-based measure of the investment grade, U.S.-dollar-denominated, fixed-rate taxable bond market. The S&P 500 Index is a market capitalization-weighted index generally considered representative of the U.S. stock market. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of 23 developed markets including the United States. The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 2,000 single-manager funds that report to HFR Database. Index returns do not represent investment returns or the results of actual trading. Index returns reflect general market results, assume the reinvestment of dividends and other distributions, and do not reflect deduction for expenses or taxes applicable to an actual investment. Unlike most asset class indexes, HFR Index returns reflect deduction for fees and expenses. Because the HFR indexes are calculated based on information that is voluntarily provided actual returns may be higher or lower than those reported. The HFRI indexes are based on information self-reported by hedge fund managers that decide, on their own, at any time, whether or not they want to provide, or continue to provide, information to HFR Asset Management, L.L.C. Results for funds that go out of business are included in the index until the date that they cease operations. Therefore, these indexes may not be complete or accurate representations of the hedge fund universe, and may be biased in several ways. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results. Standard deviation is a measure of the volatility of returns. The higher the standard deviation, the greater volatility has been. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Diversification strategies do not guarantee investment returns or eliminate the risk of loss. See the “Index Definitions and Asset Class Risk Disclosures” link above for index definitions.
1 All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
Investing in stocks involves risk and their returns and risk levels can vary depending on prevailing market and economic conditions. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. Foreign investing has additional risks including currency, transaction, volatility and political and regulatory uncertainty. Alternative investments, such as hedge funds, are not appropriate for all investors and are only open to “accredited” or “qualified” investors within the meaning of the U.S. securities laws. They are speculative and involve a high degree of risk that is appropriate only for those investors who have the financial sophistication and expertise to evaluate the merits and risks of an investment in a fund and for which the fund does not represent a complete investment program. While investors may potentially benefit from the ability of hedge funds to potentially improve the risk-reward profiles of their portfolios, the investments themselves can carry significant risks. Hedge funds trade in diverse complex strategies that are affected in different ways and at different times by changing market conditions. Strategies may, at times, be out of market favor for considerable periods which can result in adverse consequences for the investor.
Key Takeaways
- Adding hedge funds to an allocation with a traditional blend of stocks and bonds has historically increased returns and decreased risk, as charted above.
- Alternative investments can provide valuable diversification, especially during time periods when the correlations between U.S. stocks and bonds prices have been positive.