21.2.4 Multi-strategy Funds

Multi-Strategy Funds

In a multi-strategy fund, a single fund manager strategically invests in multiple fund strategies within a single fund vehicle. For instance, a manager might integrate relative value, event-driven, and directional strategies into one fund. The key advantage here is the flexibility to adapt the exposure of the fund in response to market movements or the manager’s strategic discretion.

Benefits of Multi-Strategy Funds

The diversification achieved by incorporating various strategies can provide several benefits including:

• Reduced Volatility: The inclusion of multiple strategies can help stabilize returns as the impact of one disappointing segment can be offset by other successful strategies.
• Enhanced Risk-Adjusted Returns: By diversifying, the overall risk profile decreases without an equivalent decrease in potential returns, improving the Sharpe ratio.
• Reduced Concentration Risk: Mitigation of both security-specific and strategy-specific risks.

Risk Management

Despite the benefits, multi-strategy funds come with their own set of risks:

• Each underlying strategy bears specific risks inherent to that investment approach.
• The multitude of strategies managed by a single manager may reduce the time available to monitor each security and overall market movement efficiently.

Multi-Strategy Funds vs. Fund-of-Funds (FOF)

Multi-strategy hedge funds and fund-of-funds differ fundamentally:

• Multi-Strat Fund: Managed by a single entity running diversified strategies.
• FOF: Distributes capital across various managers, each managing different strategies.

Advantages of Fund-of-Funds

FOF investments provide increased diversification benefits, allowing for broader strategy and manager coverage. This further reduces both concentration and operational risks.

However, a common criticism of FOF is the added management fees, which may erode overall returns:

• The multi-tier level of management fees from both the overarching FOF manager and individual hedge fund managers diminishes net returns for investors.

Key Takeaways

• Multi-strategy funds offer a blend of different investment strategies under a single management framework.
• Diversification within these funds can lead to reduced volatility and improved risk-adjusted returns.
• It’s crucial to distinguish between multi-strategy funds, run by one manager, and fund-of-funds (FOF) which diversify across multiple managers.
• While FOF investing provides broader diversification and decreased concentration risk, it also potentially erodes returns through layer of management fees.

Frequently Asked Questions (FAQ)

Q: What is a multi-strategy fund? A: A multi-strategy fund is managed by a single manager who invests in multiple investment strategies within the same fund.

Q: What are the benefits of investing in a multi-strategy fund? A: Benefits include reduced volatility, enhanced risk-adjusted returns, and decreased concentration risk.

Q: How does a fund-of-funds differ from a multi-strategy fund? A: A fund-of-funds invests across various strategies managed by different managers, unlike a multi-strategy fund, which is managed by a single manager with multiple strategies.

Q: Why might fund-of-funds have lower returns compared to multi-strategy funds? A: The multi-tier structure in FOF involves additional management fees, which can erode returns.

Glossary of Terms

• Relative Value Strategies: Investment strategies that seek to exploit valuation disparities between related financial instruments.
• Event-Driven Strategies: Strategies that capitalize on events such as mergers, acquisitions, or corporate restructuring.
• Directional Strategies: Strategies that bet on the directional movement of the market or individual securities.
• Sharpe Ratio: A measure to calculate risk-adjusted return, denoting how much excess return you receive for the extra volatility endured for holding a riskier asset.
• Concentration Risk: The risk associated with any single exposure or risks that may result in non-diversified portfolios.
• Fund-of-Funds (FOF): An investment strategy of holding a portfolio of other investment funds rather than investing directly in stocks, bonds, or other securities.