| How hedged are hedge funds? |
Recent market downtrends have resulted in the collapse of several hedge funds. Andrew Chiok takes a closer look at the reasons why.
The first hedge fund was introduced to the US investing community in 1966. Utilising his superior knowledge to pick out over and under-valued stocks in a market believed to be inefficient, hedge fund originator Alfred Winslow Jones designed and implemented trading techniques which evolved into a variety of strategies employed by hedge funds today.
Hedge funds are deemed “protected” or “hedged”. They are considered to be an important part of the alternative asset class, where returns are uncorrelated to the financial market. According to Mr David Lam, managing director for Clients, Asia Pacific of investment firm GAM, institutional investors, particularly pension fund providers, are finding it more and more difficult to meet their long-term investment goals due to the weak equity market that diversification from traditional investments such as the inclusion of hedge funds has become essential.
The number of hedge funds in the US has more than doubled since year 2000 to reach 10,000, according to Bloomberg. This pool of private capital now sits atop assets worth some US$1.9 trillion!
But of late, a series of high profile collapses has raised the question of “How hedged are hedge funds?” To be sure, big name funds are failing. Bloomberg further reported that David Slager and Timothy R. Barakett who run the Atticus European Fund lost more than 13 per cent while Lee Ainslie, who heads Maverick Capital, lost nine per cent through January 25, based on figures from SYZ & Co, which tallies hedge fund returns. This is fairly low compared to the 2007 performance of funds returns at 27.7 per cent and 26.9 per cent, respectively.
“In today’s stressed environment of low liquidity and high volatility, hedge funds are finding it very difficult to protect capital,” observes Mr Lam. Trends used to be clear cut, but the case is not the same today. For instance, just a year ago, it was an easy trade: just go short financials, short sub-prime, long non-US and emerging markets. However, the same strategy cannot promise the same results if used this year. Market trends notwithstanding, the socalled ”bad” balance sheets of major banks have led them to make harsh margin calls. Take for example, the case of Tequesta. Unlike its larger and higher profile rivals, the US$150 million Tequesta Mortgage Fund has steered clear of mortgage and assetbacked credit markets now getting walloped by the real estate bust. Still, Tequesta folded up in March this year. Its collapse is attributed to the credit squeeze forcing big players like Citigroup to pull lines of credit from otherwise healthy investors. To top it all, many hedge funds are products of a bull market. These funds made highly leveraged bets on, until recently, a rising market. While some bought into commodities, others have invested heavily in emerging markets, and still more are involved in loans market. But when the credit crunch and talks of recession surfaced, these markets, as a consequence, have collapsed.
Yet the fact is, “When managed effectively, the inclusion of hedge funds in a portfolio can minimise the effects of adverse market movements and enhance the likelihood of out-performance. Also by helping to stabilize returns and balance a portfolio over the full investment cycle, they help to protect capital in down markets,” explains Mr Lam.
He further adds that active management within funds, as well as active asset allocation in managed portfolios are ways to meet clients’ diverse needs.
How innovative one’s approach to trading is will determine his competitive edge. For instance, all of GAM’s fund managers, whether employed or contracted by them, are unconstrained in their investment management processes and decisions. This is perceived to be the best route to consistent and superior investment performance.
GAM has also pioneered the multi-manager concept in the 1980s, believing that no single investment house can employ all the best fund managers. It maintains a highly disciplined process of identifying, selecting and monitoring talented fund managers. For this, GAM is seen to be a world leader in multimanager investing and to offer a wide range of styles and strategies.
“Hong Kong and Singapore are mature enough for alternative investment strategies”, Mr Lam says. Institutional investors in both markets are very sophisticated and they are always looking for active management to achieve absolute returns.
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