Best days may be over for
hedge funds
(Filed:
25/09/2004)
Investors should beware when exclusive clubs
open their doors to all comers, writes Max King
Hedge funds have been defined as funds which
fail to hedge risk and anyone tempted to chase this fad had
better beware that it rarely pays to be late onto an
investment bandwagon.
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Make sure you are an early bird when it comes to
hedge funds |
The mysterious world of hedge funds emerged
from its discreet offices in Mayfair, Geneva and Manhattan
during the last decade, seeking more money from a wider range
of investors.
These unregulated, offshore investment funds
have grown exponentially and now control more than £500billion
of assets worldwide. Their high charges and, in particular,
performance fees have made their managers fabulously wealthy,
attracting ever more ambitious and self-confident individuals
to the industry.
Satisfying the industry's voracious appetite
for capital requires an ever-increasing supply of new
investors. In the early years, these were mostly wealthy
families with their money in tax havens.
Among those who followed were charitable
foundations, private banks and American pension funds. Now the
salesmen are focusing on the slowcoaches: British insurance
companies, pension funds and ordinary investors.
To appeal to these markets, an old solution has
been adopted. Investment trusts have been set up to invest in
a broad portfolio of hedge funds selected by a "fund of funds"
manager. The first of these, Alternative Investment
Strategies, was launched at the end of 1996 and is managed by
International Asset Management. Since then, there has been a
steady increase in the number and size of these funds.
The discount to net assets at which these funds
used to trade has disappeared in the last year, and the
average fund has risen 5 per cent in value. Unfortunately,
this does not mean that their underlying performance has been
good. The average change in net assets over one year has been
a fall of 3 per cent, and over three years, they have lost 4
per cent.
Mark James, director of research at ABN Amro,
attributes this to the falling dollar. "The underlying assets
of most of these funds are in dollars, which most managers
have chosen not to hedge." In other words, the hedge funds
have been un-hedged.
This is confirmed by Andrew Gibson of IAM, who
points to dollar-based returns of 13 per cent over one year
and 20 per cent over three years for Alternative Investment
Strategies. Even in dollar terms, 2004 is proving difficult
for funds of hedge funds.
"Choppy, erratic markets make it difficult to
trade successfully," says Andrew Gibson. "Hedge funds need
orderly markets, or major dislocations, to perform."
This did not discourage ABN Amro from raising
an additional £130m for Dexion Absolute, managed by a
well-regarded team at Harris Associates in Chicago, or Close
Brothers from raising £70m for the Close Man Hedge Fund. This
fund attracted criticism for its charges of more than 4 per
cent per annum, plus performance fees.
Hedge funds are finding it increasingly
difficult to devise strategies which generate positive returns
while avoiding the risk of losses. This does not surprise
Robin Angus, a veteran expert on investment funds. "A growing
amount of capital is chasing after a fixed amount of market
inefficiency," he says, "so returns are bound to fall."
Performance data provides supporting evidence,
showing that returns in excess of cash have fallen from more
than 13 per cent in the mid-1990s to less than 5 per cent
now.
To make matters worse, research has shown that
the average fund of hedge funds has under-performed the
average hedge fund by 3 per cent per annum.
The "fund of funds" managers are supposed to be
able to sort the good managers from the bad, and to be able to
obtain access to funds which are closed to new investors
(sensibly, good managers don't want their returns to be
diluted by a flood of new money). Instead, they are collecting
but not earning an extra layer of fees.
"Anyone who thinks that you can generate
returns of between 10 per cent and 15 per cent per annum
without taking a risk is living in dreamland," says Robin
Angus. "Hedge funds are not transparent or easy to understand.
Funds of funds compound the opaqueness and the charges while
diluting the flair on which successful funds depend."
Andrew Impey, head of UK equities at Singer
& Friedlander, is also unimpressed by hedge funds. "Our
clients have only a minute exposure to hedge funds," he says.
"If you are bullish on markets, you will do better in
conventional equity funds; if bearish, you should hold
cash."
Mick Gilligan, head of fund research at the
stockbroker Killik, recommends risk-averse clients to buy into
conventional investment trusts that have learned the lesson of
protecting capital before seeking growth, such as Personal
Assets, British Empire Securities or SR Europe.
Others recommend the better funds in the
"cautious managed" sector of unit trusts, which have a similar
exposure to equity markets as the average fund of hedge funds,
but much lower charges and better performance records.
These funds all performed well in the bear
market and are likely to provide continued steady, low
volatility returns. What they don't do is give the investor
the feeling of membership of an exclusive club.
But those who were once members of Lloyd's will
remember that when clubs for the rich open their doors to all
comers, the best days for profits may be past.
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