Suppose you could pair equity-like returns with an airbag-like feature during volatile periods?

HEDGE STRATEGIES—A NEW INGREDIENT THAT MAY HELP REDUCE VOLATILITY

Adding this “new ingredient” to a conventional portfolio has historically helped improve returns and reduce volatility.1

20-Year Period Ending June 30, 2018

For illustrative purposes only; not representative of any Franklin Templeton fund’s portfolio composition or performance. Past performance is no guarantee of future results.

The New Ingredient—Hedge Strategies

You may have never looked into hedge funds before. Why would you? The high minimum investment requirements, low transparency, and general illiquidity kept them inaccessible to most individuals. Hedge funds were the province of ultra-high net worth individuals and institutions.

But even taking all those restrictions into account, hedge funds made sense for that small segment of the investing population. These investors were looking for a new source of returns with additional diversification beyond a traditional stock and bond portfolio.

Aren’t Hedge Strategies Too Risky?

Many people believe hedge funds are inherently more risky than stocks and bonds. However, the investors who use hedge funds are not trying to add risk to their portfolios. On the contrary, they use hedge funds to help reduce risk while improving return potential.

Now, individual investors can access these same kinds of “hedge strategies” through a much more familiar investment vehicle: a mutual fund, which also offers liquidity and lower costs.

How Have Hedge Strategies Reduced Portfolio Volatility?
By Performing Better When Stocks and Bonds Were Down

Earlier we suggested hedge strategies could function like an airbag during periods of volatility. That means because they have historically performed better when stocks and bonds were down, they have the potential to reduce the impact when stock and bond returns decline.2

Down Calendar Years for U.S. Equities
25-Year Period Ending December 31, 2017

Down Calendar Years for U.S. Fixed Income
25-Year Period Ending December 31, 2017

For illustrative purposes only; not representative of any Franklin Templeton fund’s performance. Past performance is no guarantee of future results.

Hedge Strategies Are Now Available in a Mutual Fund for the Everyday Investor

Mutual funds investing in hedge strategies are designed to break down the old barriers and make these alternative investments more broadly available to individual investors. With hedge strategies offered in a mutual fund, investors get access to the benefits of these alternatives in a format that can be added easily to a portfolio allocation.

Six Reasons Some Investors Prefer Hedge Strategies in a Mutual Fund Instead of a Traditional Hedge Fund

Hedge Strategies in a Mutual Fund

 

Hedge Fund

Yes

Access to Your Money on a Daily Basis

No

Yes

Simple Tax Reporting

No

Yes

A Regulated Investment

No

Yes

Low Minimum Investment

No

Yes

Limits on Leverage

No

Yes

Holdings Reported Quarterly

No

Why Add Hedge Strategies to Your Portfolio?

Adding hedge strategies to your portfolio of stocks and bonds may help by offering:

  • The Potential for Reduced Volatility
  • New Source of Returns
  • Additional Diversification

Historically low bond yields, a rising rate environment and volatility in the equity markets have many investors seeking new ways to diversify traditional asset allocations. Hedge strategies deserve consideration as part of your overall strategy in today’s market.

Work with your financial advisor to determine whether hedge strategies in a mutual fund are appropriate for you. Together you can decide how best to adjust your overall portfolio to incorporate this new ingredient.

Get Started with Hedge Strategies from
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Franklin K2 Alternative Strategies Fund

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Brooks Ritchey, Head of Portfolio Construction, Responds to Common Questions

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  • Hedge strategies, quite simply, are strategies that are betting on some securities to do well, while also betting other securities will underperform the market and may even go down. So it’s a two-way form of investing. It’s an alternative approach to generating returns rather than just owning stocks and bonds outright and hoping everything you own goes up.

  • Hedge funds are not too risky for the average investor. It seems to be some sort of a myth that really doesn’t have any basis in truth. The volatility in the new liquid form of hedge funds (liquid alternatives) is generally lower volatility than equity portfolios and even some bond portfolios. So that is an incorrect assumption that they’re too risky. Their intent is to reduce risk... to provide a “hedge” against risk.

  • Well, a hedge is generally a good thing. Many elements of life are hedged. We have auto insurance as a hedge in case of a car accident, for instance. A hedge fund is quite simply an investment methodology where portfolio managers are trying to purchase a company or a bond that they think is a good investment, but as a hedge, just in case they’re wrong about the general market direction, they will sell short a security they think is mediocre.

  • It varies by your risk profile, your risk appetite; it varies by your age; it varies by what else you hold in your portfolio. Many investment advisors have a minimum recommendation of 2% in hedge fund allocations. That’s quite a low level in my opinion. It might not make a big difference, but it can give people some satisfaction that some of their holdings are generating performance differently than stocks or bonds. The big endowments and institutional investors may have as much as 20–25% invested in hedge funds and liquid alternatives. It really does vary. Personally, I think the average investor ought to be talking to his or her advisor about holding around 10% of their investments in hedge strategies.

  • It really depends on where you think the forward market cycle is for equities and bonds. A lot of our investors are using hedge funds and liquid alternatives as a replacement for cash holdings because cash is yielding close to zero. Hedge funds are actually performing quite well lately, so they’re a very nice use of extra cash lying around. If one thinks the equity market is at risk, then one should take some allocation from equities and put it into hedged-type products. If one is worried about rising interest rates, maybe you want to move a little bit away from the bond allocation towards hedged funds. But it really depends on the outlook of the individual investor and his or her advisor.

  • In short, the theory is that if you hold traditional hedge fund investments that aren’t daily priced or daily liquid, you should earn a higher return because they’re holding illiquid securities that may take one to three years to really meet their full value. Since the global financial crisis, we don’t think there are a large number of illiquid special situations that warrant holding something illiquid to maximize the value. We don’t think the illiquidity premium is as large today as it has been in the past.