Many attractive opportunities have recently emerged in the hedge fund space, but it’s critical for investors and advisors to conduct strict due diligence with respect to these investments, institutional managers said on Tuesday.

At a panel discussion held by the Alternative Investment Management Association Canada in Toronto, the industry experts said hedge funds show strong potential in the current market environment.

“Hedge funds are able to outperform for good reasons, not the least of which is having a more flexible approach to the investment process — they’re not constrained by holding securities or sectors in a benchmark,” said Darren Spencer, a director at Los Angeles-based fund of hedge fund manager Dorchester Capital Advisors.

Andy Stewart, president and COO at Man Investments Inc., agreed that hedge funds are likely to outperform, thanks to their ability to effectively navigate volatile markets.

“I wouldn’t be surprised to see the market down 20% from here; I wouldn’t be surprised to see it up 20% from here,” he said.

But performance tends to vary drastically from fund to fund, and this will likely be true to an even greater extent amid the current level of market volatility, Stewart said.

“There’s going to be a huge dispersion in hedge fund returns,” he said. As a result, he said it’s critical to carefully select fund managers who are able to dynamically adjust their investment according to the market environment.

It’s also important to keep in mind the various risks inherent in hedge fund investments, warned Daniel MacDonald, an alternative investment portfolio manager at the Ontario Teachers’ Pension Plan. When assessing a hedge fund manager, he said it’s important to review their historical risk management.

“If they’ve had really good risk discipline in the past, chances are they’ll have really solid risk discipline going forward,” said MacDonald.

The panelists said institutional managers and fund of funds have begun conducting more stringent due diligence since the financial crisis, including more carefully assessing the exposures of the funds in which they invest, and conducting background checks on hedge fund managers. But even with extensive due diligence, they admitted that risks remain.

James Suglia, a principal at KPMG, said it is not sufficient to only conduct due diligence prior to investing in a hedge fund. Rather, he said it should be a process that lasts the duration of the investment.

“Ongoing monitoring is as important, if not more important, than the upfront due diligence,” he said.

On the topic of regulation, the panelists did not display resistance to the idea of tighter rules and regulations for the alternative investment industry.

“Thoughtful, effective regulation is actually a good thing in this industry – it will clean up a lot of the issues,” said Stewart. But he added that if regulators commit to cracking down on this part of the market, they must invest in new resources and knowledgeable staff.

“One of the things that has to happen if you want to have effective regulation is increased budgets to bring in the right people who actually know what they’re doing, understand things, have experience, and have seen scenarios to be able to make judgments,” he said.

IE