For much of the past two decades, hedge funds occupied a privileged position in family office and private wealth portfolios. They promised uncorrelated returns, downside protection and access to strategies unavailable through conventional asset classes. The reality, for many allocators, has been more mixed. Toby Watson, drawing on decades of experience evaluating alternative investment strategies at the institutional level, brings a clear-eyed perspective to what family offices should actually expect from hedge fund allocations – and what alternatives deserve consideration.
The hedge fund industry has undergone significant change over the past fifteen years. Assets under management have grown substantially, the range of strategies has expanded and the investor base has broadened considerably. Yet for many family offices, the experience of allocating to hedge funds has been one of gradually declining enthusiasm. Performance relative to simple equity benchmarks disappointed across much of the industry during the extended bull market of the 2010s, while fee structures have remained stubbornly high relative to net returns delivered. Toby Watson has followed these developments closely and sees the current moment as an opportunity for family offices to reassess their hedge fund allocations with a more demanding framework.
The Hedge Fund Promise and the Reality of Delivery
The case for hedge funds was always built on a few core propositions: that skilled managers could generate positive returns regardless of market direction, that hedge fund strategies provided genuine diversification benefits, and that fee structures were justified by the alpha delivered. Each of these propositions has been tested over the past decade.
The alpha question is perhaps the most fundamental. Academic research has consistently shown that a significant proportion of hedge fund returns can be explained by factor exposures – to equity market risk, credit risk, momentum and other systematic factors – rather than by genuine manager skill. This does not mean that all hedge funds are simply expensive beta, but it does mean that the burden of proof for genuine alpha is higher than many allocators have historically applied. Toby Watson has argued that family offices which evaluate hedge funds rigorously – decomposing returns into systematic and idiosyncratic components – tend to improve considerably allocation decisions than those that rely on track records and marketing narratives alone.
Realistic expectations are the foundation of good allocation decisions, and Toby Watson has consistently emphasised that family offices should define precisely what role a hedge fund allocation is intended to play before committing capital. Is the objective genuine downside protection? Uncorrelated return generation? Access to a specific strategy otherwise unavailable? Each objective implies a different set of criteria for manager selection and a different benchmark for success. Toby Watson, whose career at Goldman Sachs included extensive exposure to alternative investment strategies across multiple market environments, has noted that the family offices most satisfied with their hedge fund allocations tend to be those that defined their objectives most clearly at the outset.
How Toby Watson Evaluates Hedge Fund Allocations
Toby Watson’s framework for evaluating hedge fund allocations begins with strategy clarity. Understanding precisely what a manager does – the instruments they trade, the sources of return they target and the market conditions under which they are likely to perform or struggle – is a prerequisite for any serious allocation decision.
From strategy clarity, the analysis moves to fee assessment. The net-of-fee return is the only return that matters to the investor, and fee structures should be evaluated relative to the realistic return potential of the strategy and the availability of cheaper alternatives providing similar exposures. Toby Watson has noted that this comparison is often unflattering for hedge funds, particularly in strategies where systematic or passive alternatives have become available.
The third dimension is operational due diligence. The governance, risk management and operational infrastructure of a hedge fund matter as much as the investment strategy. Toby Watson’s years at Goldman Sachs, working across complex investment structures and counterparty relationships, reinforced a discipline of treating operational assessment as a core part of manager evaluation rather than an afterthought.
The Liquidity Dimension of Hedge Fund Investing
Liquidity terms vary considerably across hedge fund strategies, from daily liquidity in some managed futures funds to quarterly or annual redemption periods with gates and side pockets in more complex strategies. Toby Watson has argued that liquidity terms should be directly aligned with the liquidity profile of the underlying strategy – and that mismatches between the two have historically been a significant source of problems for investors during periods of market stress. Family offices need to understand not just the headline redemption terms but the practical liquidity available under stressed conditions.
Strategies That Still Merit Consideration
Not all hedge fund strategies have disappointed equally, and Toby Watson sees genuine merit in a select few areas:
- Global macro strategies – when genuinely unconstrained and driven by rigorous macro analysis – can provide meaningful diversification in environments where traditional assets struggle. The 2022 period demonstrated this clearly, with disciplined macro managers generating positive returns during a year that was deeply challenging for both equities and bonds.
- Systematic and quantitative strategies have demonstrated more consistent performance relative to their stated objectives than much discretionary equity long/short funds, partly because their factor exposures are more transparent and their fee structures have generally become more competitive.
Toby Watson has emphasised that even within these more favourable categories, manager selection remains critical. The dispersion of returns within hedge fund strategies is wide, and the difference between a top-quartile and median manager can be substantial.
Toby Watson on the Alternatives to Hedge Funds
For family offices reassessing their hedge fund allocations, the relevant question is not simply whether to reduce exposure, but what to do with the capital instead. Toby Watson’s perspective, shaped by his experience at Goldman Sachs and his current work as partner at Rampart Capital, is that the alternatives depend entirely on what the hedge fund allocation was meant to achieve.
If the objective was genuine diversification, direct allocations to macro-driven absolute return strategies may deliver similar benefits at lower cost. If the objective was downside protection, a carefully structured options programme or dynamic asset allocation framework may be more reliable. If the objective was return enhancement, private credit or infrastructure allocations may offer better risk-adjusted outcomes with greater transparency. Toby Watson’s approach is always to start with the objective and work backwards to the most efficient structure for achieving it.
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