Making the case for hedge funds as next-generation diversifiers

Episode notes

Multi-Asset Strategist Adam Berger explains the challenging environment for traditional diversification and explores hedge funds as a potential solution.

If traditional diversification is less reliable, what comes next? Listen to Multi-Asset Strategist Adam Berger make a case for hedge funds as next-generation diversifiers in conversation with host Christopher Perret on the #InvestorExchange podcast.

01:52: What drew Adam to multi-asset investing?
03:45: What brought Adam Berger to Wellington Management.
04:25: What are investors most concerned about today?
06:38: What's changed in diversification?
07:27: What do the new generation of diversifiers have to offer?
12:07: Approaching hedge funds for the first time
13;14: Being mindful of hedge fund shortfalls

Transcript

Adam Berger: There are scenarios in the world, where inflation more than growth is going to drive markets. I think the other characteristic of all of these past bear markets, where bonds rally to your protection, was that they were sort of classic, deflationary recessions. We worried about growth slowing more than anything else. But if we have scenarios where the market's going down, the stock market's going down because we're worried about inflation going up, bonds just don't offer that degree of protection. You have to figure out something else in the portfolio that's going to play that role.

Chris Perret: Over the past two decades, investors have grown accustomed to a simple but powerful idea: when equities struggle, bonds may provide protection. But that relationship has started to break down. In 2022, we saw stocks and bonds decline together, challenging one of the core assumptions underpinning portfolio construction for decades. At the same time, we're entering a different macro regime, one defined by higher inflation, more volatility, and greater dispersion across markets. And, historically, those are the types of environments where hedge funds have tended to perform best.

So, allocators are asking an important question: If traditional diversification is less reliable, what comes next? That's where the idea of the next generation of diversifiers comes in. Today I'm joined by Adam Berger, head of multi-asset strategy at Wellington, who spends his time engaging with clients and institutional investors around the world, helping them navigate exactly these challenges.
Adam, it's great to have you on the podcast.

Adam Berger: Great to be here.

Chris Perret: So, Adam, let's start with your background. You've spent your career at the intersection of research, portfolio construction, and working with clients. What drew you to multi-asset investing and how has your perspective evolved over time, especially given how closely you work with clients today?

Adam Berger: It really started with, you know, the interest in helping clients solve problems. I started my career at Goldman Sachs and spent five-plus years sort of bouncing around different areas. But what most impressed me about the firm was just the focus on clients, and that if you could get things right for clients, you can add a lot of value and become an invaluable partner.
And I had the opportunity relatively early in my career to be in a group called pension services that tried to bring the best of Goldman's resources to bear for its big pension clients globally, recognizing they had a lot of needs and they weren't necessarily always being met by the entire firm and trying to make the make Goldman feel small for these clients. And it just impressed me. You know, just how interesting set of investors they were. But also how you had billions of dollars of asset allocation decisions being made by a handful of people. You know who that's a big burden, that it's a struggle. And the firm really tried to get it right and help them make the best decisions they could.
I think that's really what got me fascinated by the space. And combined with the fact that it really combined the interpersonal side of investing with the data, the analytics, and the research.

Christ Perret: All right, so after Goldman, you go to AQR. Tell me about that experience.

Adam Berger: AQR really focused on quantitative investing. And I landed there just months ahead of the quant meltdown in 2007. So, seeing how the firm reacted to that, seeing how the firm managed through the global financial crisis in 2008, gave me a huge appreciation for how powerful risk management could be, having a risk mindset in your decision making, and just the importance of really thoughtful analysis, and understanding your portfolio and what you own at any point in time.

Over time, I've also realized, our minds naturally go to the crisis and people want to structure our portfolio for the worst bear market. But you also have to remember that those are the exceptions, not the rules. And you can be too conservative or be the too anchored to the bad, that you miss a lot of the potential upside.

Christ Perret: What brought you to Wellington in 2012?

Adam Berger: In some ways, that was bringing me back full circle. I knew a little bit about Wellington, I knew about the morning meeting, the idea that you had all these global investors thinking about companies and a range of dimensions, including the quantitative one ― really strong quantitative resources here ― but also macro economist and PMs who were sitting across from company management teams and trying to understand strategy and competitive advantage in a way a quant process may not always capture, just that breadth, that 360 vision. And then, honestly, the people and the collaboration and the idea of being able to learn from and build my skills alongside really talented investors.

Chris Perret: You spent a lot of time with investors in your role today. What are they talking about? What are they most concerned about?

Adam Berger: It's a range of topics; I would say, you know, understanding the changes that we're seeing in the world first and foremost. Geopolitics is clearly one ― we see that in just the conflicts that are cropping up around the world and how important those are to markets. But also artificial intelligence is a huge one, where it's had an enormous change in the composition in the market cap weighting. I talk to clients a lot about the fact that the US, which for most of my career was 45% to 55% of global market cap, is now more like two-thirds. That's a big change. So, there's a lot of worry about a bubble.

What's notable to me is a lot of this change has been driven by the economics, right? These are companies generating huge profits, earnings, free cash flow. In a way that's very different than what we've seen in the last decade or two. But I still think it's a challenge for institutions to navigate. And it's hard to navigate markets that are more concentrated.

Chris Perret: And what about on the other side, on the fixed income side? What are you hearing from clients as it relates to that space?

Adam Berger: So, 2022 was sort of a watershed moment for the institutions that I talk to. You know, you had stocks and bonds both going down in a calendar year for the first time in my investment career and for the first time in decades. And that really caused investors to think about diversification and what the complexion of diversification was going to look like going forward.
So, lots of discussions around what role this fixed income play in a world where it might not be a diversifier in the way it's been? But also, how do you think about diversification in a world where you have maybe you can't bank on fixed income playing that role.

Chris Perret: Because of the inflation impact, because of geopolitics?

Adam Berger: Inflation first and foremost. That was the key in 2022 was, you know, a degree of worry about inflation that we really hadn't engaged with for decades, certainly going back to prior to 2000. But also, and maybe this is the case more today, the outlook for inflation is challenging too. Even before what we've seen with the oil price in the last few weeks, you look at fiscal spending, you look at globalization, you look at underinvestment in commodity production over time. All of these are inflationary forces that I think are going to be with us, not just for a year or two, but for the medium to long term.

Chris Perret: So, let's dig into this a little bit more. For a long time diversification felt relatively straightforward. Stocks for growth, bonds to cushion the blow should stocks fall What’s changed?

Adam Berger: I think it really is that inflation point we just touched on. There are scenarios in the world, where inflation more than growth is going to drive markets. I think the other characteristic of all of these past bear markets, where bonds rally to your protection, was that they were sort of classic, deflationary recessions. We worried about growth slowing more than anything else. But if we have scenarios where the market's going down, the stock market's going down because we're worried about inflation going up, bonds just don't offer that degree of protection. You have to figure out something else in the portfolio that's going to play that role.

Chris Perret: So that leads us into the new generation of diversifier. What options do investors have on the menu today? I think we all can say bonds are still going to play a role in portfolios, but how do investors in your conversations, how are they thinking about surrounding that with other diversifiers?

Adam Berger: So, there really are two major spaces people are looking at. The first is real assets, which should go up when, when inflation is rising, so, that's a natural place to look to. You have to think about the correlation characteristics. Some of those may be more correlated with equities, but again in a crisis we've seen even in recent periods there are asset classes like commodities and commodity-sensitive equities that that can do well.

And the other big one is hedge funds, really because they can be constructed to be explicitly market neutral. So even more than any broad asset class where you're sort of banking on a historical relationship continuing, hedge funds by design ― or at least a subset of hedge funds by design ― are really market neutral, where they should not have a correlation, not just to equities, but also to rates, and currencies, and other things across market environments.

Chris Perret: I think we've all seen the industry data, it's been a much more fruitful environment for alpha generation within the hedge fund space, especially when you compare it over the prior, let's call it 2010s decade.

So, with that backdrop, you know, in your conversations with investors around the world, why are they attracted to hedge funds? What types of categories are they looking at? And, you know, are they using it more in the use case of a return driver, a diversifier? Talk to me about that.

Adam Berger: So, I would say it's all over the map. But let me start with the time period backdrop. I think you alluded to something that's really important. Even as we are worried about the need for diversification and even as we talk about heading into or being in a world that is more volatile, with more business cycles and more uncertainty, that could be a good environment for hedge funds. A Goldilocks environment is great for stocks and bonds, actually, but it's not great for hedge funds. If you have low interest rates, if you have low equity dispersion, if you have low macro volatility, there just is not as great an opportunity set for hedge funds to generate returns.

The best ones will generate returns across environments, but there are natural headwinds imposed by those to hedge fund returns. The converse of that is a much better environment. And that's the world we've been in really post-COVID. We've had higher interest rates than we did at the 2010s period. We've had more macro volatility. You see that China's economy is not in the same state that the US’s is in. So, there's big macro dispersion, and we've seen equity dispersion as well. So, all three of those factors have been driving better hedge fund returns. And we think for the foreseeable future we could continue to see a supportive backdrop for hedge funds.

You know, in some ways a little bit like with bonds, the return that you get over time, over the medium term, is sort of the cost of the diversification, right? The return you're getting from hedge funds relative to equities is the cost of holding that diversification of the portfolio. If hedge funds are returning low-single digits and equities are up 10% a year, that's a big cost. If hedge funds can generate mid- to high-single digits, maybe equities are actually in that same bucket over the next decade. And there's very little opportunity cost on top of the fact that again, we think they're really going to offer protection when equities sell off.

Chris Perret: So, the important question then is money in motion. In your conversations are you finding that CIOs, you know, head of hedge fund or public assets, are they are they making the move?

Adam Berger: They are, and I'd say they're doing it in a few different ways. Everything we've touched on has really been focused on diversification. So, in that sense, people are looking to market-neutral hedge funds ― oftentimes multi-strat ― because they're looking for hedge fund portfolios that combine a range of different inputs, you're not subject to the ups and downs of one particular hedge fund style or approach. By design, I think the engineers who are building these multi-strat hedge funds ― and I see it in my colleagues here ― are putting a lot of thought into risk management, to understanding what they own, what the risks are. And so I think that maximizes your chance that when you need it, when markets do get volatile, when equities do sell off, most importantly your hedge fund portfolio can ride through that. And it's not correlated strongly in either direction. So, it's really about the alpha just providing a cushion to return. So that's use case number one.

Use case number two is more on the traditional alpha-generation side, where investors who are struggling with alpha generation in long-only equities are looking to portable-alpha-type structures where they say, you know what, instead of in a market that we think is more efficient, let's go passive with our broad equity exposure and use hedge funds as an alpha source. I think that's most comfortable for investors who've been at the hedge fund game for a bit, who know managers, who feel confident in their manager-selection ability. But I think folks who have done it are ramping up, and even people who are maybe newer to portable alpha but are comfortable with hedge funds are saying, you know, this is a really interesting return source, let me just find ways to get more of it into my portfolio.

Chris Perret: What would you say to investors approaching hedge funds for the first time, or say, for the first time in a while? Because it is, a space where you have to really focus on the skill of the manager, not necessarily a prediction of future results.

Adam Berger: I would even take one more step back. From a governance perspective, actually, both of the things we're talking about ― real assets and hedge funds as diversifiers ― are exposures that many people had had in their portfolios at some point in the last decade or two, but may have taken out, right? Hedge funds, there was some disappointment. It was a very different hedge fund world. After the global financial crisis, a lot of people felt hedge funds didn't do the job they were supposed to do. People had commodities in their portfolio and thought, you know, we haven't had a lot of inflation, we're just not getting return from these. But I think on a forward-looking basis, both of these are critical allocations.
So, I think it's the governance decision. How do you get your stakeholders (for many people that’s a board) or many to understand what am I investing in? What is the structure of it? And why do I think, you know, it really has a role to play in a portfolio today relative to the past? And we have been in this unusual period where, for all the time and effort that most of the people I talk to you put into diversification, you haven't needed it, right? Stocks and bonds have been great. So, it really is about reminding people, what's your time horizon, what's your outlook. I think it is sort of back to basics, if that makes sense, as step one.

Chris Perret: And what shortfall may exist today that didn't exist in the past?

Adam Berger: Absolutely. Diversification really matters. It didn't matter for the last decade. It’s likely to matter much more and you, you need a different set of strategies today to do that than you did before.

Chris Perret: Let's hit some rapid-fire questions. What's something about hedge funds or diversification that's personally changed your mind?

Adam Berger: So, I would say notwithstanding a big focus of everything we've touched on today, more on the market neutral side, I've come around to the fact that hedge funds with some equity exposure, you know, like equity long/short strategies, can play a role as well. Again, I see the most sophisticated allocators using those, combining them with an equity overlay to sort of normalize the equity exposure.
But I do think there are managers that just that's their natural area, that's where they're going to work best and generate the best returns. So, I do think that, even strategies with beta, can play a role in a portfolio if you understand what you're getting and how you're going to fit it into your broader set of exposures.

Chris Perret: You talk to investors a lot. What's a debate or question that keeps coming up in conversations?

Adam Berger: I actually think the efficiency of the US stock market is an interesting one. Lots of great Wellington colleagues in this building and around the world invest in US equities and I think do a very good job of it. You know that's definitely a contrarian view right now. So, just lots of debate on where to be active, where to be passive, and how to optimally blend those in a portfolio.

Chris Perret: Small caps? What's the biggest part of that debate?

Adam Berger: I think it's across the board. I think small cap’s a challenging one because there, I think, people are questioning the alpha and the beta, right? It's such a different market today. Fewer companies are going public early in their life cycle. So it's just the dynamics of investing in small cap are very different. And that's a market where, just in 2025, we had enormous speculative activity. So, if you were a thoughtful PM who built a portfolio of companies you really liked and you liked the management teams, you probably got trounced by the market where there were stocks with much more speculative bent and no products and no earnings in the near term.

Chris Perret: What's one thing when investing in hedge funds that actually matters most for investors to get right?

Adam Berger: You alluded to this: It's manager selection. At the end of the day, you know this is an it's not a market exposure. It's an alpha source. It's about the people you're investing with.
The one other thing I would note, you know, we take a long-term view in a lot of what we do, I think understanding firms that have the structure in place to be around for the long term and to have their incentives aligned with yours over the long-term is really important. I think business stability of hedge funds. So, we've seen the industry professionalized a great deal. It's not as much someone in a garage, but, you know, if you're investing with someone in a garage, understand, how are they going to live through a drawdown? How are they structurally prepared for a range where, their strategy faces some headwinds for a period.

Chris Perret: Last one ― and I think I know the answer to this ― but are we early or late into the hedge fund story? Are they going to be enduring diversifiers?

Adam Berger: I think we're still very early. I had a client ask me recently: Is the pendulum swinging back from private equity to hedge funds? And I think, you know, both of these are strategies that have a role to play in the portfolio. But I think we saw the pendulum swing so far in the 2010s away from hedge funds toward buyout funds raising billions and billions of dollars. And that was the right thing. Interest rates were low. Actually, as I said, it was a tough environment for hedge funds. It was a great environment for private equity. I think at the margin, especially in sort of the big buyout space that pendulum is swinging from private equity back to hedge funds today.

Chris Perret: Adam, really appreciate you joining us. This was a great conversation. I think the big takeaway is that the next generation of diversifiers is forcing investors to think differently about portfolios, and hedge funds are right at the center of that evolution. Thanks again for being here.

Adam Berger: My pleasure. Thanks for having me.

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