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Hedge Funds as an Alternative, Uncorrelated Return Stream

Stockholm (HedgeNordic) – Norwegian Formue is the largest privately-owned wealth management firm in the Nordic region, overseeing over NOK 140 billion in assets under management, a team of about 400 employees, and over 20 offices across Norway, Sweden, and Denmark. At its core, Formue is committed to offering institutional-grade solutions to high-net-worth individuals. These solutions are designed using eight building blocks that represent different asset classes. Hedge funds as a group represent one of these blocks, with Formue standing as one of the largest hedge fund allocators out of the Nordic region.

Formue’s portfolio construction process incorporates eight building blocks, spanning real estate, private equity, hedge funds, private credit, along with traditional asset classes. “The allocation to each bucket is customized and tailor-made based on the risk model and risk preferences of each client,” explains Cian Walsh, Head of Hedge Funds and Private Credit at Formue. This tailored allocation approach not only streamlines Formue’s functions as an allocator but enables clients to benefit from significant cost reduction via fee rebates and/or performance fee netting from the underlying managers in each bucket.

On average, across all client portfolios, Formue allocates approximately eight percent of its NOK 140 billion investment portfolio to hedge funds. However, each client’s allocation to this asset class can vary widely, ranging from zero to 30 percent. “The reality is that everyone is different, with varying age groups, needs, liquidity requirements, and risk tolerances,” explains Walsh. Each client’s investment mix and allocation to hedge funds is carefully tailored based on their unique liquidity needs and risk preferences. “Some clients prefer to avoid hedge funds altogether, while others seek higher allocations to active risk management (i.e., alternatives) and passive allocations for long only.”

“An allocation to a diversified hedge fund portfolio is the most liquid and diversified allocation within the alternative asset classes, and is effectively an allocation to ‘active risk’.”

Drawing from his extensive experience in manager selection within the hedge fund space, Walsh views hedge funds as providing “an alternative, uncorrelated return stream.” Traditional long-only exposures to markets have become commoditized, argues Walsh, saying that “if you seek beta exposure to global bond or equity indices, it’s readily available at a minimal cost.” However, investors “seeking uncorrelated return streams delivering consistent, compounding returns over time need to look towards alternative strategies,” according to Walsh. “An allocation to a diversified hedge fund portfolio is the most liquid and diversified allocation within the alternative asset classes, and is effectively an allocation to ‘active risk’.”

Risk Seeking and Protection Strategies

While the global hedge fund industry is a heterogeneous universe with a wide variety of strategies, Formue classifies hedge fund strategies into three main categories: equity, credit, and macro. “The credit and equity-type of strategies are what we classify as risk-seeking strategies,” explains Walsh, who, along with Edvard Jansen and Trygve Skjæggestad, oversees the allocation to hedge funds and private credit. Within the equity category, strategies encompass equity long/short, event-driven, low net, market-neutral, and directional approaches, among others.

“The credit and equity-type of strategies are what we classify as risk-seeking strategies.”

Focusing on Formue’s credit-focused hedge fund investments, Walsh points out that “our credit managers operate beyond the limitations of benchmarks and indices, targeting highly specific market segments with minimal reliance on leverage.” Walsh underscores that “their expertise lies in accessing parts of the market that are more difficult to access, which requires skill.” Typically, risk-seeking strategies related to equity or credit constitute 50 to 70 percent of Formue’s allocation in the hedge fund portfolio.

The remaining allocation is directed towards macro strategies, which serve to “play a capital protection role in the portfolio.” This category includes systematic macro funds, discretionary macro funds, trend-following CTAs, and other related strategies. “When things come out of whack, when interest rates are too low, for instance, or equities are too expensive, these strategies can capitalize on mean reversion,” explains Walsh. “This exposure allows our portfolio to weather significant market fluctuations, such as sudden shifts in equity or credit markets. We expect our exposure to macro strategies to deliver positive returns during such volatile periods.”

Dynamic Allocation

The trio overseeing hedge fund allocation at Formue dynamically adjusts exposure to these three broad strategy categories based on prevailing market conditions. A notable example of this adaptive approach is evident in Formue’s shift from nearly 50 percent exposure to equity strategies before the onset of the Covid pandemic and the low-interest, low-inflation environment, to a range of 30-35 percent in a higher interest rate setting. Explaining this shift, Walsh elaborates, “After more than ten years of quantitative easing, we anticipated tighter financial markets. With the tightening conditions following ten years of bumper returns from equity markets, we adjusted our exposure.”

“While the wind has slowed for equities, credit strategies, on the other hand, have started to get more wind in their sails.”

Walsh likens the approach to “stacking the odds in your favor” and “sailing with the wind at your back.” Accordingly, Formue reduced exposure to equity strategies and increased its allocation to credit strategies. “While the wind has slowed for equities, credit strategies, on the other hand, have started to get more wind in their sails,” says Walsh. “Investing in credit today can yield returns of seven to twelve percent with relatively low risk.” This reallocation has resulted in “a still fairly healthy” risk-seeking component of the portfolio. 

Additionally, Walsh notes a slight increase in exposure to macro strategies, reflecting a more favorable environment for such approaches. “When significant moves occur in interest rate markets, macro funds tend to perform well.” In summary, Walsh emphasizes, “The primary purpose of Formue’s hedge fund portfolio is to provide our clients with a complementary and diversified exposure to traditional long-only markets.” He goes on to add that “an allocation to hedge funds is a 100 percent allocation to active risk. Inherently this means that the hedge fund portfolio should underperform traditional indices during years of strong equity and bond returns and outperform during weaker return/loss years.”


Despite the abundance of strategies available in the hedge fund industry, Walsh and his team prefer to maintain a highly concentrated portfolio of hedge funds for their clients. “We aim to avoid over-diversification,” says Walsh. “In academic terms, if hedge funds deliver 100 percent alpha and you over-diversify, you risk diluting the alpha return stream to zero. Alpha is a finite resource, even within the hedge fund universe despite what hedge fund marketers might say otherwise.”  Therefore, Formue strives to keep the portfolio focused, with the top twelve manager allocations typically comprising about 80 to 85 percent of the portfolio. “For each manager, we might also have exposure to two or three different products,” elaborates Walsh.

“We aim to avoid over-diversification. Alpha is a finite resource, even within the hedge fund universe despite what hedge fund marketers might say otherwise.”

“The remaining portion includes tail managers, closed managers, or managers under evaluation that we are trying out,” explains Walsh. Formue categorizes managers into tiers, with tier-one managers commanding a significant portion of the allocation. For instance, four or five tier-one managers might collectively account for about half of the portfolio. On average, Walsh and his team replace one or two managers each year. “That’s what we call the churn rate, which implicitly means our average exposure to managers is going to be three, four, five years,” explains Walsh.

Nordic Managers

Formue currently holds no exposure to Nordic managers in its hedge fund portfolio, although it has previously allocated capital to Nordic-based managers.  “Broadly speaking, Nordic hedge fund managers do not often meet the institutional standard that we demand for our clients’ investments,” explains Walsh regarding the absence of exposure to Nordic managers. “Many of these managers operate under domestic regulations, which often lack the more robust checks and balances expected from institutional-level hedge funds,” he elaborates. “Although there may be some talented individuals, we all know that an individual does not make a team and brings with it significant key-person risk. There is simply not enough of a talent pool readily available to build out a fully-fledged institutional standard hedge fund – infrastructure, compliance, risk, marketing, investment analysts.”

“Broadly speaking, Nordic hedge fund managers do not often meet the institutional standard that we demand for our clients’ investments.”

This is not just a Nordic problem, but a global problem, notes Walsh. “The top-tier hedge funds will continue to be headquartered in the larger population pools around the world in order to secure continual access to human capital and not be over-reliant on one or two talented individuals.”

Walsh also points out that the majority of Nordic hedge funds do not offer the uncorrelated return streams sought by Formue and other large institutional investors. Similar to other European markets in France or Germany, the Nordic region is primarily characterized by smaller and more retail-focused hedge funds, notes Walsh. “We do see them across our desk all the time, and while some may initially seem promising, closer examination reveals inadequate infrastructure, operational shortcomings, and regulatory gaps,” explains Walsh. 

“Even among the few that show potential, they very often fail to raise enough capital to come beyond what we see to be the breakeven AUM in today’s competitive environment.”

“Further, and most often, they simply have enough capital under management for us to consider an initial allocation,” continues Walsh. “Even among the few that show potential, they very often fail to raise enough capital to come beyond what we see to be the breakeven AUM in today’s competitive environment.” Walsh estimates this breakeven point to be around $250-300 million, essential for providing the hedge fund with the necessary resources to develop their operations, attract and retain personnel, and fulfill all regulatory and compliance requirements. “Seen from a different angle, this is why hedge fund platforms have been so successful in recent years. They attract talented individuals and smaller teams looking to manage $50-300 million while handling regulatory and compliance matters, business management, and other related activities.”


Hedge funds have played an important role in the investment portfolios of Formue’s high-net-worth clients across the Nordics. Walsh expects the hedge fund industry to continue to thrive amid changing market conditions. Looking ahead, Walsh anticipates financial markets reverting to the volatility patterns observed prior to the 2008 financial crisis. “It’s not necessarily the hedge fund volatility profile as a collective that will change. It’s more about financial markets returning to their pre-quantitative easing behavior,” Walsh concludes. “Therefore, I believe this shift alone will be sufficient to support the hedge fund industry further. In addition, with passive management continuing to disrupt and commoditize the long-only space, allocators will increasingly look towards hedge funds and other alternative asset classes for active and unconstrained investment management.”

This article is part of HedgeNordic’s Nordic Hedge Fund Industry Report.

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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