Alternative investments: The big picture

Published: 16 January 2017

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Hedge funds and alternative credit funds are a key part of the alternative investment landscape, which in turn is a segment of the larger asset management industry. They are referred to as “alternative investments” because some of the investment tools and methods they use are different to those used by “traditional” asset managers who sell products to the general public and other investors. Such tools help to generate lower-risk and steadier returns.

In essence, three things set hedge funds apart from so-called “traditional” funds –

  1. They are unconstrained – meaning they are not pegged to an index like many passive funds
  2. They can go ‘short’ – meaning they can hedge risk more effectively than other types of funds
  3. They can use leverage – typically meaning they may borrow (usually a comparatively modest amount) to grow overall profits.

The value of the investor assets managed by hedge funds globally amounted to around $3.4 trillion in Q3 2017, according to Preqin, a data provider. To put that in context, the overall asset management industry globally managed about $79 trillion in assets at the end of 2015, according to PwC. 

The hedge fund sector globally comprises around 5,500 fund management businesses and about 10,000 individual funds (investment products). It employs close to 400,000  people worldwide, according to an AIMA/Preqin study in 2017. These businesses and individuals pay billions each year in corporation and income taxes.

Much hedge fund activity may seem complex and esoteric. But without interest rate derivatives trading by macro hedge funds, to name one example, banks and other lenders would find it more difficult or risky to offer fixed-rate mortgages to their customers. Without commodity derivatives trading by hedge funds, airlines would find it more difficult to control the costs related to their fuel consumption. Without credit derivatives trading by hedge funds, banks may have to liquidate wholesale portfolios of SME loans and restrict finance to an already cash-starved sector.

Moreover, hedge funds and alternative credit funds perform important roles as the investment choices of socially useful investors such as pensions, charities, university endowments and sovereign wealth funds.

And there are direct "real economy" impacts. Credit funds are increasingly lending directly to businesses, filling a void left by bank retrenchment. Many alternative investment management firms are active shareholders and help to drive improvements in the operating performance and governance of the companies in which they invest.

Further reading

The Way Ahead - Helping trustees navigate the hedge fund sector by AIMA, CAIA.pdf