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Here’s how to push against the ‘I want to buy hedge funds’ argument

So some of your clients are urging you to invest their portfolios in hedge funds? You’re not alone. Many advisers report such requests, borne of their clients’ frustrations with the mediocre returns of equity managers or concerns about an imminent bear market.

In almost all cases, however, the right thing to do is to push back. This column discusses a few of the arguments you can use when trying to do so.

Consider first whether hedge funds are the best way to reduce risk. Hedge funds are called hedge funds for a reason, and as a general rule they are less risky than the stock market. Only if you can provide clients with a superior alternative for reducing risk do you have a compelling argument for not investing in hedge funds.

Fortunately, just such an alternative exists in a simple and cheap portfolio that invests 60% in a stock index fund and 40% in a bond index. Show your clients the accompanying chart, which compares the volatility of various groups of hedge funds with that of a simple 60:40 portfolio.