By Lewis Braham
Wealthy investors are getting nervous. Or at least, that is how you could interpret the surge of money into hedge funds and other alternative investments in 2025.
Traditional hedge funds, which are only accessible to the rich, are designed to protect their investors from market downturns by shorting, or betting against, stocks and other securities. Total global hedge fund industry assets hit a historic $5 trillion milestone for the first time last year, with net asset inflows of $116 billion, the strongest calendar year for investor inflows since 2007, according to the latest HFR Global Hedge Fund Industry Report.
Hedge funds are part of an array of so-called alternative investments, or alts, that investors can use to diversify their portfolios or to generate higher returns than traditional stocks and bonds. Should you get on board? Unfortunately, the answer is it depends. Alts are more complex than regular funds -- and more expensive.
Understanding which kinds of alts are best for playing offense or defense within a portfolio is essential, as some asset classes, like private equity and private debt funds, can actually increase your risk while appearing to be safe. Moreover, fund selection is vital, as individual alt fund returns vary more than the returns of traditional mutual funds -- a concept known as dispersion -- sometimes with extreme highs and lows within the same fund category.
Liquid Versus Private
The case for hedging your bets with alts is strong today. The S&P 500's Shiller price-to-earnings ratio -- a popular valuation measure based on average inflation-adjusted earnings from the previous 10 years -- recently hit 40. It has been higher only one other time since 1871; it hit 44 in 1999, right before the dot-com bubble burst.
The question is which kind of alt to buy. "Accredited investors" with either a net worth exceeding $1 million or an annual income above $200,000 can buy traditional hedge funds, but now there are numerous "liquid alt" mutual funds and exchange-traded funds run by reputable firms like AQR and BlackRock, which have smaller minimum investment requirements and no other restrictions to getting in. They are also generally cheaper than hedge funds, which frequently charge 2% of assets plus 20% of profits as an annual fee.
The choice often comes down to restrictions on buying and selling, also known as the liquidity of an alt fund's portfolio. "Both types of structures have a lot of merit," says Kenneth Heinz, HFR's president, referring to private hedge funds compared with ETFs and mutual funds. "The more liquid the strategy, the less pronounced is the benefit of owning a hedge fund." Private hedge funds often restrict shareholder redemptions to once a quarter so they can more effectively invest in illiquid securities. For the wealthiest investors and institutions, their fees can also be less than the standard "2% and 20%" and negotiable, Heinz says.
Long-Short Strategies
Given that many stocks are very liquid, there's little reason that a traditional long-short style hedge fund couldn't work well in a liquid alt mutual fund or ETF structure. Long-short funds own stocks their managers like on the long side of their portfolios and bet against stocks they dislike on the short side, thereby neutralizing some or all of the funds' sensitivity to market moves. This sensitivity, or correlation, to the S&P 500 or another fund benchmark is measured by a statistic called R2.
For instance, the AQR Long-Short Equity mutual fund has a 27.4% five-year annualized return as of Dec. 31, 2025, versus just 8.0% for the average fund in the HFRI Directional Long-Short Index. (Because many private hedge funds don't report daily performance numbers, it is better to use quarterly or monthly performance for comparisons.) For comparison, the average fund in Morningstar's Long-Short Equity category for liquid alts had a 9.7% return.
AQR's mutual fund is quantitatively run, using computers to pick many stocks as opposed to doing deep fundamental research on each company. It recently held 926 positions on the long side of its portfolio and 873 on the short side. Because of the fund's long-short balance, it has proved to be less volatile than the stock market and a good diversifier. It was up 18.8% in 2022, when the S&P 500 was down 18.1%. Its R2 in the past five years is a low 6.3, which compares with 100 for an S&P 500 index fund.
That is impressive, yet one can see the advantages of the traditional hedge fund structure with Crescat Global Macro Hedge fund. It had a 130% return in 2025, crushing the 7% return of the HFR Macro Total Index, thanks in part to private investments in gold and precious-metals miners that are too illiquid for a public mutual fund. Since the fund's Jan. 1, 2006, inception, it has produced an annualized 11% return versus the 1.6% of the HFRX Global Hedge Fund Index. That is while having a negative 41.8% downside capture ratio with the S&P 500. That means that if the S&P 500 fell, say, 10%, Crescat was up 4.18% during that period on average throughout its history -- an excellent diversifier, in other words.
Crescat Capital CEO Kevin Smith says he could never see his fund being a liquid alt. Accredited investors must agree to lock up a portion of their money for three years to access the fund. "You can get 25% of your money out after one year, another 25% out after the second year, and then no lockup after three years," he says. The fund requires a minimum investment of $500,000. "Attracting long-term-oriented investors into our funds is very important," Smith adds. "That exclusivity allows us to invest in earlier-stage companies to express our themes and not have to worry about being forced into a [shareholder] redemption scenario." His firm's two largest miner company holdings currently, San Cristobal Mining and Silver Bow Mining, are private.
Global Macro
Global macro funds make long and short bets based on broad macroeconomic trends. In Crescat's case, Smith is playing a "fiat currency debasement" trend that's causing currencies to lose their value against gold.
Global macro and equity long-short are the two hedge fund categories favored by investment firm Evanston Capital, which has some $4.4 billion invested in alternative assets. In January, Evanston published its annual Hedge Fund Outlook, which said the advantage these categories have in the current market environment is a wide dispersion both in individual stock returns and macroeconomic outcomes.
"For global macro, we think it's this deglobalization trend that is leading to much more varied economic conditions across regions globally, " says Kristen VanGelder, Evanston's co-chief investment officer. Countries with economic policies that were moving in lockstep after the financial crisis of 2008-09 by keeping interest rates near zero have had radically different approaches since the Covid crisis in 2020-21 and inflation's resurgence in 2022, with some keeping rates high and others lowering them, she notes. Meanwhile, tariffs and trade wars have only amplified the differences, with countries such as the U.S. seeking to deglobalize with isolationist trade policies. "This backdrop is creating a much richer set of trading opportunities for global macro managers," VanGelder says.
Unlike in the long-short category, there aren't really many suitable investment options among liquid alts with a global macro style. There are only 15 mutual funds and ETFs in Morningstar's Macro Trading category. BlackRock Tactical Opportunities, Fulcrum Diversified Absolute Return, and MFS Global Alternative Strategy are three decent ones.
Interval Funds
The most illiquid securities can be found in private-equity and debt funds. There really is no traditional liquid alt to mirror these. However, there is an increasingly popular structure known as an interval fund that provides access to these asset classes, sometimes even for investors who aren't accredited. Such funds typically allow investors to redeem only up to 5% of the fund's total assets once a quarter or semiannually.
Interval funds are a subset of what are known as evergreen funds, which include private business development companies, or BDCs, as well as private real estate investment trusts. Private BDCs and REITs are less regulated than interval funds, so they can apply more leverage than interval funds and needn't provide quarterly redemptions, although they often do in practice. They are generally available only to accredited investors.
Currently, 197 interval funds exist, according to Morningstar, with the largest being the private-credit fund Cliffwater Corporate Lending, with $33 billion in assets. Cliffwater has a 10% five-year annualized return, high for a debt fund. Plus, it seemingly has no volatility. But its stability is deceptive because the private credits it invests in don't generally trade daily like public bonds.
Because of stale pricing, private-equity and debt funds may not be truly uncorrelated alternative asset classes and may not provide as much diversification to investors as raw returns suggest. The co-founders of alt fund shop AQR Capital, Cliff Asness and David Kabiller, joke that such funds are "volatility laundering," as the real underlying business and economic risks don't show up in the funds' shares prices.
"Private equity and debt can be a good thing," Kabiller says. "But investors need to understand the underlying economics of what they're investing in. If you've got a big equity allocation in public markets in the [artificial-intelligence sector], and then you invest in lots of private equity in the AI space, you need to understand, 'How much correlation and risk do I have? Am I doubling up on a bet?' "
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February 19, 2026 03:00 ET (08:00 GMT)
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