Threadneedle has built up a strong range of hedge funds in recent years and we firmly believe that they have an important role in a sophisticated investor’s portfolio. However, we also believe in the importance of diversification.There is an old dictum that states that the market will always do whatever it has to do to confound the majority of investors’ expectations. In the late 1990s, equity funds were booming and a number of hedge funds were geared long-only funds – possibly rather a risky strategy. Some big names also pulled back from the hedge fund sector during this period. However, in the last five years the equity market has suffered a massive collective hangover from these excesses. As a result, the absolute returns that hedge funds can offer have proved extremely attractive. Moreover, hedge funds have found a lot of good short ideas to boost returns. Outside of hedge funds, investors have also rediscovered the joys of bonds and real estate. Equity investors are still timid and fearful. As a result, in Continental Europe and the UK, forward price/earnings ratios are back at the levels last seen in the 1990s – at a time when inflation and interest rates were considerably higher than they are today. That is not to say that we see a roaring bull market in prospect. We do not. However, corporate profits are generally improving at a reasonable rate and we see slow economic growth continuing as the oil price rather than higher interest rates acts as a brake against any overheating. For us this means there is some real value in the stockmarket. In particular, we see little discrimination between the valuations of companies with attractive prospects for earnings growth and those without. So there should be good rewards for patient stockpickers. In this situation, a portfolio composed of a single asset class may represent a considerable opportunity cost, so we would urge diversification with a balance of equities, bonds, property and hedge funds. You don’t believe us? A lot of people don’t – and that’s why there is opportunity in the market. When everyone believes share prices are going up forever, it will be 1999 all over again.