Multi-strategy hedge fund primer: deep dive into diversification

In summary

Multi-strategy hedge funds seek to maximise risk-adjusted returns by investing in a variety of underlying investment strategies, or differing sub-strategies of the same master strategy. They often employ flexibility in terms of capital, aiming to allocate dynamically to the best opportunities and shifting resources to where they are most needed, or even staying away from certain strategies or assets altogether. They are often favoured by investors looking to achieve consistent returns across different market cycles. Scalability is another reason why multi-strategy funds are popular, particularly with larger allocators; more capital can be allocated to successful portfolio managers quickly and they have the ability to hire more managers to run similar portfolios. This scalability, that can lead to the creation of behemoths, is a handicap for some but an advantage for others. There is a significant size bias within multi-strategy, which is somewhat dominated by a small number of very large, established firms.

Multi-strategy funds stand out as having the highest proportion of returns attributable to alpha when looking at alpha/beta P&L decomposition analysis. It is also one of the master strategy groupings with the lowest volatility, largely due to the diversified nature of their investments. You can read more about this analysis in Aurum’s industry deep dives. Consequently, multi-strategy Sharpe ratio tends to be among the highest across the hedge fund industry, while maintaining among the lowest volatility. However, multi-strategy hedge funds are not a homogeneous group and they can vary enormously; adopting different business models, areas of focus, risk parameters, levels of concentration, liquidity requirements and fees. The size and complexity of multi-strategy hedge funds means that carrying out investment and operational due diligence requires significant experience and resources and is not for the faint hearted.