Suddenly hedge funds are ubiquitous. What's up?
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Hedge-fund managers are struggling to make money this year. This is clear from the performance of published hedge-fund strategy benchmarks: many different types of funds from arbitrage funds to long/short funds have turned in disappointing performances. And yet every day one reads of more and more traders and traditional fund managers setting up hedge funds. What is going on?
First, a good deal of continued misinformation from the media. Hedge funds are invariably lumped together by the financial press with (risky) ‘alternative investments’ such as private equity and commercial property. (Property as an ‘alternative’ investment? Only during the cult of equities, which really took off during the 1980s and 1990s.) Yet ‘hedge funds’ do not represent a distinct asset class; their managers invest in anything that moves, so the way the media talks about them often doesn’t make much sense. The use of leverage, or borrowed money, can be anything from promiscuous to nil. Some hedge-fund managers eschew high risk; others welcome it. About the only thing that hedge funds have in common is that they can invest in what they like and take a pragmatic approach to fees - a situation traditional managers have long been envious of.
Hedge funds also blur the boundaries between categories of fund manager. ‘Traditional’ managers, previously limited to investing solely along index-relative lines, are belatedly starting to venture into absolute-return strategies. Simultaneously, ‘alternative’ (hedge fund) managers, having been swamped with more capital than they know what to do with, are branching out into long-only strategies. This apparent free-for-all represents a long overdue recognition of the primacy of absolute-return investing over index-tracking. Over the long run, investors of all kinds should benefit.
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Professor Harry Kat of the Cass Business School at City University warns that hedge funds are no panacea for investors. He is undoubtedly correct. Both institutional and private investors have flooded in because recent returns from traditional investments (specifically, stocks, bonds and cash) have been disappointing. But it all comes down to context. To suggest that hedge funds are inappropriate investment vehicles for a given type of investor is like saying that premiership footballers are a waste of space because they can’t help you with your tax returns. It all depends on expectations and intent. Hedge funds will not work for all investors - but many of them have shown, over time, an ability to generate positive returns in difficult markets, and an ability to reduce overall volatility within a balanced portfolio.
Hedge funds will always be a relevant option for investors with sizeable exposure to stock and bond markets who wish to offset, or mitigate, those risks. If, as I believe, we are genuinely in a low nominal-return environment for the foreseeable future, expect more headlines announcing hedge-fund launches. This is not a bubble, merely a reflection of capitalism’s genius at providing investors with what they believe they want.
Tim Price is senior investment strategist at Ansbacher & Co Lt
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