The most important reason for including hedge funds within a balanced investment portfolio is to diversify effectively. Perfect in the current market environment but investors will need to prepare themselves for hedge fund casualties as the start-ups which benefitted from the market bull run of 2003-7 find it more difficult to cope with a bear market.So it will be vital for we in the financial services industry to know what we are putting into our clients’ portfolios.

But at a fascinating lecture on hedge funds at the Raymond James Investment Services annual conference recently from Professor Harry Kat of the Cass Business School, we learned that every hedge fund follows its own strategy and that even funds classified by the same strategy tend to produce completely different returns. That is, if we can rely on the returns as presented. Professor Kat went on to say that the data collected in commercial hedge fund databases is not audited or independently verified. His own researchers have to spend time taking out errors to analyse performance effectively.

So, can we be sure what we are putting into client portfolios?It can also be easy to regard hedge funds as an asset class, particularly when APCIMS allocates a 5% weighting to hedge funds in its balanced and growth portfolios. But hedge funds follow particular strategies and it is incumbent on us as advisers to know what the strategy is and how it sits in our portfolios and whether the funds are following that strategy. But poor quality performance data is not all for Professor Kat alluded to the “marketing materials (which) are often highly suggestive, emphasising the good and wonderful while ignoring the less attractive elements of hedge funds”. Caveat emptor!