Iain North of Aurum Funds makes a case for hedge funds as a risk reducer, arguing that some critical analysis easily separates the bad apples from the rest of the bunch.

Over the past week or so a few of my colleagues have been reviewing our neighbourhood's Christmas sandwiches.

There is now even a blog created for the ongoing reviews. From high street chains to local gourmet cafes, each sandwich carries its own qualities and, critically, its final rating.

During each lunchtime lively debate takes place – quality of bread, ratio of cranberry sauce to meat, which medley of vegetables to include? Loaf or baguette? And as expected, everyone has their own opinion and favourites, leading to some spirited discussion over the lunch hour. What is very clear, however, is that no two Christmas sandwiches are created equal.

While the above may suggest otherwise, my colleagues spend the majority of their time analysing hedge funds, constantly evaluating the many components that make up each of the world's 10,000-plus hedge funds. Like the Christmas sandwich, this mass of funds may look the same from a distance, but this is far from reality.

There are some great hedge funds, some average hedge funds, and some horrible hedge funds. A common area of frustration for us as hedge fund investors is the negative press that the industry can often receive in the media.

It appears that people love reading about hedge funds, and more often than not their more sinister undertakings. As allocators we see all sides of the industry, and while we admit that there can be instances of wrongdoing, hedge funds now play an increasingly important role across the UK pension market to the benefit of savers and retirees.

Contrary to popular belief, the majority of hedge funds can actually reduce portfolio risk relative to the more traditional pension fund approach of allocating to equities and bonds.

With global bond yields at ultra-low levels and many equity markets at all-time highs, many pension funds are looking to diversify their overall risk and allocate, or increase their allocation, to alternative investment strategies.

For many, however, this is a daunting process as each fund has its own unique characteristics: investment strategy, quality of personnel, operational structure, risk management, asset size, and overall philosophy of managing capital to name a few.

Not too dissimilar to the intricacies of the revered Christmas sandwich with its endless permutations? it is a critical job for trustees and advisors to make the effort to differentiate between hedge funds and not view all funds the same; the former approach can greatly improve portfolio quality while the latter could end up leaving a bad taste in the mouth.

Written by Iain North, senior analyst, Aurum Funds