Hedge Fund Street

Hedge Funds Not As Strong As Equity Markets: Report

Data compiled by the Hennessee Hedge Fund Index shows that consistency in the equity markets has led stocks to outperform hedge funds through the first 50 weeks of 2006. Hedge funds have gained 10.06% thus far in 2006, compared to 14.2% for the S&P 500 Index. Banknet360.com reports:

Poor performance in May left hedge funds in the dust of stocks. The S&P is poised to have only one negative month in 2006 for the first time since 1995, according to Charles Gradante, a managing principal of the Hennessee Group LLC.

Read more: Hedge Fund Performance Trails Equity Markets

Window To The Future Of Hedge Funds

That the hedge fund industry is a risky proposition is something that’s been screamed from rooftops by all and sundry. Just about everyone who knows anything about the industry adds his two bits about how dangerous it is and how the industry can make you lose all your money in one felt swoop.

So it is only natural to wonder why any cautious investor would want to dally with hedge funds. Especially organizations like pension plans and nonprofit organizations. The Bank of New York seems to have found the answer to this difficult question. In a recent study, “New Frontiers of Risk: The 360° Risk Manager for Pensions and Nonprofits”, the bank found that these organizations were attracted to hedge funds because they’d been badly burnt in the equity bear market after 2000. Pension plans especially suffered huge losses. And hedge funds seem to be the perfect solution to their money woes. The industry has been growing at a steady rate for the past many years and even big losses as the one suffered in the Amaranth tragedy, haven’t made a dent in this progress.

Risk does remain a huge concern with plan sponsors, but that does not deter them from investing heavily in hedge funds. According to the study, managers are now spending nearly 40% of their risk-related time on operational and political considerations. More interesting is the fact that around 80% have shown an interest in increasing the time spent on operational risk over the next five years.

According to the report, by 2010, institutions will put half of the assets directly into a hedge fund. The other half will be invested through fund of hedge fund platforms. And that means some big changes will take place in the industry in the near future. One thing these clients will insist on is tailor-made advice and consultancy services. And given the volume of assets pension plans and other organizations will soon hold in the hedge fund industry, their wishes cannot be taken lightly.

Long Lockups Make Hedge Funds Unviable

While things are definitely looking up for hedge funds, there’s still one issue that’s a big matter for concern. At present, hedge funds are walking a tighter line between helping their investors remain liquid while requiring longer lockup periods to earn profits. Banknet360.com reports:

The dilemma surrounding longer lockup periods, which run up to five years in some cases, is leading some investors to opt out of the hedge fund market, according to executives at the Global Alternative Investment Conference. But tighter competition among hedge funds means that it takes longer for hedge fund investments to pay off, others countered.

Read more: Longer Lockups Raise Hedge Fund Investor Liquidity Concerns

Is Your Hedge Fund Going Bust?

The Amaranth collapse seems to have leant credence to the popular belief that hedge funds like to take big risks and can be quite volatile in nature. However, in reality, most hedge funds primarily aim to reduce volatility and risk while at the same time preserving capital. And irrespective of the market conditions, they want to consistently deliver positive returns. This is quite a tall order and hence it makes it doubly interesting to know how you can manage the volatile with the stable to ensure consistent returns.

People who don’t know much about these funds believe that hedge funds use global macro strategies and use lots of leverage to place large directional bets on stocks, currencies, bonds, commodities or gold. Sadly, the reality is not so romantic. Less than 5 percent of hedge funds can claim to be global macro funds. Most hedge funds use derivatives only for hedging or don’t use derivatives at all. And most importantly, many funds use no leverage. So to put it simply, Amaranth is only an aberration that confirms the rule.

In Hedge Fund V/s Mutual Fund Battle, Hedge Rules

A recent study shows that when risk was measured similarly for hedge funds and mutual funds, global hedge funds achieved higher returns than mutual funds with lower risk of loss. The study looked at more than 1,600 hedge funds for five years. Over that five-year period, almost all hedge fund styles also managed to earn much higher returns than mutual funds and with less risk of loss. Is this a conspiracy by hedge funds worldwide to show that they are a better option and offer lesser risk than the staid mutual funds? You’d be forgiven if you thought like that.

However fact is hedge funds manage to pull it off more often than not, thanks to their investment strategies. Hedge funds, unlike most conventional funds, aren’t limited to a single asset class such as stocks. Within the hedge fund universe there are a wide variety of funds with a wide range of strategies and styles. Magnum.com reports:

The strong results can be linked to performance incentives in addition to investment flexibility. Unlike many mutual fund managers, hedge fund managers are usually heavily invested in a significant portion of their funds and share the rewards as well as risks with the investors. An "incentive fee" remunerates hedge fund managers only when returns are positive, whereas mutual funds pay their financial managers according to the volume of assets attracted, regardless of performance.

Read more: Hedge Funds: Protection Against An Aging Bull

This Hedge Fund Has No Use For Managers

Your search for the calmest trading floor in the world ends at Sugar Quay, a former dock on the north bank of the Thames. No, I’m not exaggerating. Here, in the headquarters of the hedge fund giant Man Group, a small number of traders quietly handle tens of millions of dollars at a time, around the clock, following directions generated by the fund’s black-box trading system, known as AHL. Revolutionary? You bet! Until now, hedge fund managers were hailed for their quirky, daring trading styles, which were supposed to be central to their success. So, have these guys, some of the smartest brains in the trade been beaten at their own game by a trio of physics majors?

AHL, named for the initials of its three founders boasts of a brain that is made up of a room full of man-high Hewlett-Packard computers. This system, which was created by three analysts who studied physics at Oxford and Cambridge Universities, boasts an annualized return of 17.9 percent since December 1990. Total returns during that time are more than 1,000 percent. Nytimes.com reports:

Black-box trading systems, as they are known, are responsible for a growing percentage of market trading around the globe, including an estimated half of all United States stock trades and a quarter of worldwide currency trades. AHL, as one of the longest-running, most successful programs on the market, has become the backbone of the Man Group’s rise to a £7.44 billion ($14 billion) market cap company.

Read more: A London Hedge Fund That Opts for Engineers, Not M.B.A.’s

$1.5 Trillion And Growing! Now That Makes Me Squirm

I’d recently written about how the hedge fund industry is slowly inching toward being able to manage more pension-fund money. A recent provision in the pension-reform bill could allow hedge funds to do away with a ceiling on how much money they can take from pension plans. These lightly regulated investment pools have traditionally limited the amount of pension-fund money they take to 25 percent of their total assets.

Now this is definitely a time for Wall Street to party. Just imagine, the industry will soon be able to invest the huge resources that rest with pension funds. However, quite a few groups are not too happy with this provision. Labor and other groups believe that hedge funds aren't adequately regulated and could threaten pensions. Of course, the SEC is determinedly pursuing its goal to regulate hedge funds, but until such regulations are in place, hedge funds could be a major cause for worry.

These funds manage about $1.5 trillion in assets and have grown rapidly in recent years. Their future growth plan is also on the upward swing and with this latest move, more funds will become available to these funds. A recent study shows that hedge funds have substantially improved their risk management practices in recent years to reduce threats to the financial system and investor losses from fund failure.

All this did make me feel that we probably don’t need to worry about regulation. But then, when you get back to the over $1 trillion figure, it does make me squirm with discomfort – so much money and no regulation whatsoever!! SEC Chairman Christopher Cox’s assurance to Congress that hedge funds "are not, should not be and will not be unregulated," does make me feel a bit secure, but these words need to be followed by proper action for us to believe that Cox means what he says!

Domesticating the hedge fund market

A recent study conducted by consultants Mercer Oliver Wyman shows that hedge funds have substantially improved their risk management practices in recent years to reduce threats to the financial system and investor losses from fund failure. Wow, now that’s something for an industry that began life as a reckless, wild thing that made immense profits and bigger losses. Sounds like they’ve let go of the fun to make consistent returns.

As per the Mercer study, hedge fund managers and banks that service the industry have made substantive strides in many dimensions of their risk management practices. The study also found an interesting aspect in the working method of hedge funds. According to the study, large established hedge funds make extensive use of sophisticated stress-tests and scenario planning. This is done to offset the likelihood of being forced to liquidate positions in an unplanned or untimely manner. Such an event could threaten market stability and lead to a structural collapse.

Goldman Sachs: Now the world's biggest hedge fund!

Alpha magazine's annual list of the world's largest hedge funds has declared Goldman Sachs Asset Management as the biggest hedge fund. New York-based Goldman Sachs Asset Management has over $21 billion in assets. The magazine puts the hedge fund’s name on top of the 100 hedge funds that were covered under the survey. In the past few years, Goldman has emerged as one of the industry's most preferred prime brokers. It helps finance and clear trades for hedge funds and often helps find them investors.

In 2005, Goldman was at number 3 and has managed to dethrone San Francisco-based Farallon Capital Management Group this year to be on the top. Farallon Capital Management Group was ranked as No. 1 in 2005 and currently stands at No. 4 with $16.4 billion in assets.

Domesticating the hedge fund market

They were supposed to be the type of people who love to take risks and indulge in edge-of-the-seat pursuits. Sounds cool doesn’t it? Sadly, that is no longer the reality about hedge funds. It’s something like the Wild West. It used to be a place where the bravest of the brave dared to go and succeed. In a way, hedge funds were out there in their own wild west until recently. Now, civilization has finally caught up with them, and they no longer want to take too many risks. Don’t believe me? Check out the recent study, which was conducted by consultants Mercer Oliver Wyman that shows that hedge funds have substantially improved their risk management practices in recent years to reduce threats to the financial system and investor losses from fund failure.

Sounds like they’ve let go of the fun to make consistent returns. However, they still have a long way to go and still more needs to be done to allay risk in the fast-growing and evolving industry, where funds invest across an increasing array of asset classes in trades that are often backed by leverage, or debt.

As per the Mercer study, hedge fund managers and banks that service the industry have made substantive strides in many dimensions of their risk management practices. The study also found an interesting aspect in the working method of hedge funds. According to the study, large established hedge funds make extensive use of sophisticated stress-tests and scenario planning. This is done to offset the likelihood of being forced to liquidate positions in an unplanned or untimely manner. Such an event could threaten market stability and lead to a structural collapse.

Hedge fund risk practices improving: Study

Hedge funds have managed to greatly improve their risk management practices in recent years to reduce threats to the financial system and investor losses from fund failure, a new study released recently concluded. However, still more needs to be done to allay risk in this fast-growing and evolving industry, where funds invest across an increasing array of asset classes in trades that are often backed by leverage, or debt, the study said. Reuters.com reports:

Still, the study, culled from interviews of more than 100 risk executives and managers at 35 top hedge funds and 15 global broker-dealers, concluded that improvements need to be made, particularly in the area of independent valuation of thinly traded securities, an increasing area of hedge fund focus.

Read more: Hedge funds have improved risk practices - study

Hedge Funds: Big gains, bigger losses

The hedge fund industry has literally exploded in size in the past three years; going from about $500 billion U.S. just back in 2003 to over a $1 trillion U.S. last year. And the most interesting aspect is the increase in the number and types of investors who have begun putting their money into hedge funds. Hedgefundcenter.com reports:

Welcome to the world of extreme leverage and to the world of hedge funds where performance numbers tend to be eye popping whether the numbers are positive or negative ones.

Read more: Hedge Fund Follies

Are hedge funds aggressive enough?

As the hedge fund industry has grown into a multi-billion industry in the past few years, it has become the focus of increased attention both from investors and regulators. Most investors believe that hedge funds are their ticket to high returns and this belief has led just about everyone to jump onto the hedge fund bandwagon.

Everyone wants to invest in a hedge fund once they are convinced that the term is synonymous with 25 percent-plus annual returns. But this kind of return creates problems with regulators who are not convinced that the extraordinarily high returns that hedge funds earn come the right way. They believe that this mode of earning is either extraordinarily risky or crooked. Hence their eagerness to protect investors and put curbs on hedge funds.

How many investors have actually asked themselves what makes hedge funds so special? Are the high returns on investment due to certain techniques, mode of investment or is it something else. I’m sure most investors are just too happy earning their high ROIs to bother about modes and methods. But to understand how the high returns come, it is important to understand hedge funds.

One of the biggest misconceptions about hedge funds is that it can provide high returns on the invested amount. Yes, the rate of return is quite good when you compare it with mutual funds. However the ability of hedge funds to generate high returns diminishes as with larger asset holdings get larger. Today, hedge funds are estimated to be managing about a total of $1 trillion or about 7 percent of total U.S. financial net worth. And returns to large hedge funds are averaging anything between 10 and 15 percent annually. This may be high when compared to the single-digit returns on US equity markets, but not as high as it used to be when hedge funds were more aggressive.

Pension funds still wary of hedge funds

Despite hedge funds being touted as the next big thing, and quite a few institutional investors now trying them out, pension funds are still wary of hedge funds. A recently released study shows that pension funds invest only a small fraction of their assets in hedge funds even as these lightly regulated portfolios pull in billions of dollars in new assets every month. Reuters.com reports:

Some of the industry's best performing hedge fund managers have turned away pension fund money both because trustees often want more transparency and because they would have to invest pension funds' big chunks of money which might make the hedge fund less nimble in trading.

Read more: Pension funds not big hedge fund investors-report

‘Hedge funds’ long term returns poor’

Hedge funds don’t generally play on a market; they play the difference or arbitrage between markets or individual securities. And this strategy seems to have paid off well for the funds since in recent years, up to $1 trillion has flowed into the sector. Finfacts.com reports:

Research by Burton G. Malkiel, a professor at Princeton, and Atanu Saha, a principal at the US Analysis Group, shows that over long periods, hedge funds significantly underperform index funds, like those based on the Standard & Poor's 500-stock index.

Read more: Research shows that hedge funds produce poor returns in long-term; Performance data subject to manipulation

Canadian Hedge Fund industry is flourishing despite Portus setback

When the Portus Alternative Asset Management Inc scandal broke out, there were quite a few who had declared death of the Canadian hedge fund industry. The players have proved other wise. Toronto-based hedge fund administrator SGGG Fund Services Inc for instance had 35 clients way back in 2003. Today it boasts of over 130 clients. The firm also expects at least 20 new hedge funds to come up in the first half of 2006.

SGGG’s total client base accounts for almost 85% of the entire Canadian Hedge Fund industry. To further drive home the point, the company’s client base has over $2 billion asset under management. Furthermore, none of its clients has closed doors and gone home. This definitely does not indicate death or even a slowdown of the industry.

James McGovern, managing director and chief executive of Arrow Hedge Partners states that the Portus fiasco has in no way dampened the spirit of hedge funds in Canada. Mc Govern is also chairman of the Canadian arm of the Alternative Investment Management Association (AIMA).

Andrew McCreath who is the head of Toronto based Waterfall Investments also shares this view. He proves this by giving the example of his own fund. Waterfall Investments was formed in May 2003 with $5 million as its asset base. Today it has almost $200 million under management. This is quite a feat considering that the fund is not even 2 years old.

The fund had been posting a strong return which in turn is pulling in more assets. Waterfall's offshore fund based on December data, has a compound annualized return of 27.4%. The fund also has the distinction of generating 98% of its returns as alpha. Alpha returns are those that are not generated due to the market. This is therefore a better indication of the funds investment skills.

The other trend that is encouraging for the industry per se is that larger and more established funds are pulling in more of the assets. This is indicative of an investor base that is looking for an infrastructure, a risk committee, governance, and also what kind of succession planning there is within the hedge fund. The hedge fund industry is therefore far away from slow down, let alone closure. Canada reports:

“One nice thing is that the people we brought on board maybe one or two years ago, who have gone through that kind of time of a building up a track record, are starting to see the bigger cheques come through the door for investment now," he said.

CDOs – The new generation hedge fund investment game plan

Year 2005 was a landmark year of sorts for hedge funds. Not only did it see doubling up of the industry’s asset base but also saw it cross the $1trillion mark. It was also a year which saw dwindling of profits and a large number of hedge fund managers close shops and go home. The year also saw SEC get into action and work towards regulating the unregulated hedge fund market. Therefore in a way it was a year that saw a good amount of upheaval yet progress towards institutionalization.

Optimists like Peter Cockhill and James Bagnall of Ogier say that the industry is in its best form ever and is expanding. Figures revealed by Cayman Islands Monetary Authority (CIMA) confirm this trend. The report made public recently by CIMA confirms that over 900 new funds have registered with it in the first nine months of 2005 itself. Cayman Islands is a kind of a haven for hedge funds because of the relaxed tax regime and the intrinsic money center that it is. CIMA also revealed in its report that growth in hedge fund registrations was up 112% from 2003 in 2004. All this further confirming the good health of the industry. We can treat Cayman figures to be quite authentic and indicative of the growth of hedge funds since more funds are domiciled in Cayman than anywhere else.

Despite all this optimism, the current returns from the industry has been far from encouraging. The optimists wave it off again say that the industry is slated for good growth. This is primarily because of the agility of the fund managers and also their innovativeness. Every passing day sees a newer strategy or a new investment class. The fund managers are continuously discovering newer areas for investing. Some of the newer area include investing in venture capital, private equity and mezzanine lending.

Today hedge fund managers are also offering open-ended investment vehicles with a private equity sub-fund element. This enables them to be a part of investment in illiquid securities as well. By doing this, hedge fund managers are making sure that investors get various combinations of risk and returns under the same roof. 

Yet another area that the hedge funds have discovered is management of collateralised debt obligations (CDO’s). Generally banks use this specially purpose vehicle to offload debt from their balance sheets. However changes in accounting rules and the new Basel II regulatory framework is allowing large financial institutions also to offload the management of the riskier elements of securitizations and the hedge funds are making use of this opportunity. For the uninitiated, CDO is a fixed income product that is a securitisation of other bonds, loans and financial instruments. It is generally used as a means of financing pools of assets such as mortgages and credit card debt.

Analysts see this kind of investment as somewhat unusual since it implies that the funds have to assure banks that they will be committed for a long duration. Traditionally hedge funds are known for their short term flings. Long term commitments is not something that comes to them naturally.

Despite this some funds like Cheyne Capital Management are proposing to come out with investment companies which will take on the management of these high yield financial investments.

The transition from a completely liquid to a somewhat illiquid investment structure is helping fund managers infuse some degree of newness in the hedge fund arena. Apart from this, it also helps them to safeguard their own position and strategy under heavy redemption requests. Hedge Week reports:

“the demand for idiosyncratic and imaginative managers continues to be high and that the need for a sophisticated, international and tax neutral jurisdiction such as Cayman remains strong.”

Hedge Funds: Are they ready to take off?

These days everybody is paying attention to Hedge Funds, the government, the investors, the fund managers and the media. With new regulatory changes, things are changing fast and opinions are changing even faster.

There is news about funds being pulled out of the market as also of new funds emerging every month. This is leaving many new investors confused about what is happening. The point to note, is that even as larger funds are facing trouble over registration, the smaller ones are sensing a new opportunity by keeping a low asset and a low clientele profile and catering to rich investors alone.

Perhaps the industry could get a big impetus if the regulations made it mandatory to publish periodic investor related data similar to what the mutual fund industry does. However, that could threaten the very nature of Hedge Fund investments as it would mean revealing all their activities and financial game plans taking away the secrecy it is known for.

Are Hedge Fund Indexes any good?

When in investing in bonds or equity, to a large extent we depend upon indexes for making our decisions. They allow us to rely on the research that goes into building the index. It isn't the same with Hedge Funds.

The volatile nature of Hedge Funds defy the use of Indexes. However, a growing number of diversified investors is leading to a number of changes in the industry including an increase in the use of indexes. However, there is no standard or composite Hedge Fund Index available for investors. Different Indexes use different calculations for reprsenting returns and use different approaches to make their analysis. The large number of strategies available further add to the difficulty of building an Index that can truly represent funds dealing in each particular strategy.

The best way to go around building an Index for investors is to build their own Indexes that answer their investment needs. This may need a little bit of hard work calling for research, study, a lot of phone calls and calculations. But then you get the best possible answers to most of your questions.

Growth of Hedge fund continues despite enhanced scrutiny

The industry that has seen its assets double up in five years to cross the $ 1 trillion mark continues to grow. The growth is despite the fact that the industry is being watched more closely by regulators than it ever was. This was made evident at the semi-annual Managed Funds Association meeting in Key Biscayne, Florida. The members evaluated the extent of money pouring into the funds and also the type of investors who are still queuing up to share the diminishing booty.

Chief amongst them are pension plans. In order to meet their payout obligations they have to generate minimum returns of 8 to 10%. This obviously is not possible by merely investing in stocks and bonds. Therefore they are forecasted to be a key contributor to the hedge fund kitty. Fund managers are busy luring this category in a big way. However they cannot accept more than 25% of their total asset base from pension plans. Employee Retirement Income Security Act (ERISA), the federal law that governs corporate pension plans, has placed the ceiling in order to minimize the risk to risk averse pension plan investors. However, the fund managers are seeking to change this law through Managed Fund Association. They want the ceiling to be raised to 50% of ERISA money.

The members also observed that the demand for hedge funds is also coming from cash-rich investors in the Middle East. This class of investor is traditionally has a lot of cash and is not afraid of investing in alternative investment vehicles. This observation was made by George Hall, founder of the Clinton Group, a large multi-strategy hedge fund that started in 1991.

Hall also said that in the era of increased scrutiny by regulators and investors, the industry continues to attract a lot of money. Investors are willing to invest in funds that are reliable and have a strong fund manager behind it. Take the case of Jack Meyer, former head of Harvard University's endowment fund, who was able to raise $6 billion for a new hedge fund. It is being said that it is the biggest ever initial fund-raising for a new hedge fund.

George Hall added that the reputation of the fund manager is good enough for pulling in the cash but one small wrongly publicized act can cause the money to leave the fund also. His fund faced the consequence of a highly publicized regulatory investigation by loosing a lot of investor money. Though the fund was completely exonerated from any wrongdoing in December 2005, it failed to get the investor confidence back. Reuters reports:

“But even if the rule is changed, hedge fund managers are still facing rising costs and demands from potential investors that often take months of work to address.”

Hiring a Hedge Fund Administrator

Hedge Fund managers are often taxed by a varied amount of work that range from administration to forming compliance reports. All these can cost a great deal of infrastructure, time and effort. Hedge Fund Administrator can take away a lot of these headaches by providing the necessary resources to managing operational and administrative activities. An administrator takes care of clients and investors, prepares compliance reports and supports all operational and administrative functions.

There are two types of services that these administrators provide,fund accounting and fund administration. Fund accounting take care of financial or GAAP reporting and other reports that are legally required to be generated. Fund administration service clients and do the administrative and accounting jobs of a fund. Even investors appreciate the services of an administrator since they know that they help keep their money safe. HedgeCo reports:

Hiring a edge fund administrator increases the size of your operations by providing a virtual administrative and operations staff. Your investors will pay approximately one basis point (0.01%) of return per month for the benefits of these services, a cost, which will barely reduces the returns of your fund, but will greatly enhance the service.

Significance of a Hedge Fund Administrator

A Hedge Fund Administrator plays a very supportive role in the management of Hedge Funds.

They provide reports on financial and tax compliance, service clients and investors and help in the administration and operation of the fund.

Hedge Fund administrators take away the headache of providing all the infrastructure that is required for carrying out all administrative and operational activities.

There are two types of service providers, those catering to fund accounting and the other to fund administration.

Citywire report confirms retail fund manager brain drain

Some time back we had covered a story about brain drain of managers to hedge funds from traditional retail investment area. This piece adds further weight to the story. Recently Citywire conducted an in-depth analysis of its database of fund managers. The result of the analysis further confirms the mass movement.

The analysis has concluded that a significant amount of talent has left the retail fund industry over the past three years. For instance way back in 2002, Citywire’s database included 152 managers. Today it is observed that at least 43 managers have moved. This accounts for a whooping 30% of the managers of the retail segment. Many of the managers have been traced and their movement has been documented. However there are some whose whereabouts are known as they have perhaps moved out of the city or country. 

The move has been attributed to a variety of reasons primary being the incentivised pay plan offered to hedge fund managers. The massive performance fees offered bY hedge funds allow managers to take home millions of pounds a year. Lock-ins and the general growth of boutiques and hedge funds all around seem to be the other relevant factors. Apart from this, what has also come out strongly is the fact that managers feel that their creativity and innovativeness is kind of stifled when they handle retail investment products. In the hedge funds mould they are able to express themselves better and can see the results rolling in. This sense of satisfaction seems to be lacking when handling other traditional investment products. Therefore statistics reveal that at least 12 percent of the managers tracked have switched to hedge funds. 

Moves of some of the prominent names are given here. Simon Roberts, formerly Tony Willis' AAA-rated co-manager on the Lazard UK Alpha fund has moved. He is currently the director of BlueCrest Equity Master Fund since October 2005.

Another top class manager to be seen following this trend is Mark Bradshaw. He is a former AA-rated manager of the Hargreaves Lansdown (HL) UK Performance fund. Although he is still registered as a fund manager with the Financial Services Authority his main activity is the stewardship of the Victory Capital hedge fund.

Former AAA-rated Hugh Hendry left Odey Asset Management but still plan to offer their services to high net worth individuals if not the mainstream retail market. At Odey Asset Management he ran the Odey Continental European fund till March 2005. He now owns the firm Eclectica Asset Management, a hedge fund boutique. He still has plans to offer long-only funds to those who can afford them.

Another major loos for the retail industry is Bill Mott, who earned an AAA rating for his skilful management of the Credit Suisse Income fund. He retired from active service in July 2003. Reuters reports:

‘However, if received wisdom is to be believed, it is also because hedge funds offer fund managers a chance to express themselves and follow their own path. This kind of urge can often be stifled by the strictures of operating within a retail environment where responsibility to ordinary investors without great expertise holds back individuality.”

Hedge funds likely to have another rough Year as the dollar slides versus yen

Industry analysts feel that 2006 may also be as lack luster for hedge funds as 2005. This apprehension was voiced after the recent sliding of the dollar against the Japanese Yen. They have made this prediction primarily for global macro funds, which make directional bets on currency, bond, commodities and stock markets, generally on the basis of economic trends. What has also happened is that even euro has slipped a little against the yen. The trigger for this might have been that Japanese investors took home European bond coupon payments. This apparently has also contributed to the dollar going down. 

analysts also feel that the reason for this may be linked to  Japan's reluctance to let the yen strengthen to a level where it feels economic growth might be damaged. Even Reuters has confirmed the trend by showing in its survey of 56 currencies that the Yen has raised to 108 per dollar by the end of 2005. Reuters reports:

"For much of last year and earlier in January, macro funds played the carry trade -- borrowing yen and selling it to buy higher-yielding currencies such as the dollar, New Zealand dollar, Australian dollar and South African rand.”

Hedge Funds – progress report for 2005

With the year 2005 already behind us, experts have finished tabulating how they fared over all in the year. One clear cut feature of the year was that the returns were abysmally low. The year recorded an average return rate of less than 7%.

Another startling fact was the overall lowering of the quantum of money that was invested in hedge funds. Research suggests that the amount has almost halved in comparison to the inflow of 2004. This year the total inflow was in the range of $60 billion-$65 billion as compared with $120 billion in 2004.

It was observed that all over the world, those investors who invested in equities were better off. This phenomenon was the same globally except in the US. CSFB's Tremont index is soon going to be out and is expected to give evidence to confirm that London-based funds fared better than their US counterparts. CSFB's Tremont index tracks more than $800billion worth of assets worldwide.

It is generally thought that the hedge funds are uncorrelated to the market. However in the last 12 to 18 months, it has been observed that correlation to the US equity market has risen quite a bit. All these observations were made by Oliver Schupp, the head of investment bank Credit Suisse's hedge fund index. 

Mr Schupp added that hedge fund managers who had a heavy equity focus and were by and large aligned European and Asian markets have fared well. However it was noted that Funds with assets coming from the US did not do quite well. Telegraph reports:
    

"Anthony Culligan, head of investments for F&C Partners, said hedge funds which performed well during the year included those which capitalised on an increasing taste for "realising shareholder value" in Japan”

Hedge funds in Egypt

Egypt and the Middle East are on the brink of a hedge fund revolution and all eyes are on them. What was a success in America and is so in Europe and the Far East, is now going to happen in the Middle East and in Egypt. For long the market has been neglected by hedge funds because of lack of regulations that would allow the trading tool as short selling is still not a very acceptable strategy.

The financial market is full of mutual funds that invest with the expectation that the value will increase – long positions. Market neutral strategies are still not the norm in the region. However the region is still attracting international attention because of the excellent bull phase experienced by the region. For instance, the Cairo and Alexandria Stock Exchange (CASE) 30 Index skyrocketed 130% last year thereby making it the top performing bourse in the region.

The first hedge fund to enter the market is from Beltone Financial Chairman Alaadin Saba and Khaled Abdel Majeed. The duo were friend and colleagues at EFG-Hermes. The hedge fund is called Mena Capital. It is registered in Bahrain and managed out of London. Also the promoters have made sure that the fund is not being marketed to the retail investors of Egypt. By making this arrangement, the hedge fund is ensuring that it does not fall into the purview of Capital Market Authority (CMA). CMA is the Egyptian equivalent of American SEC.

Mena capital is an exclusively regional fund with a modest asset base of $25 million. The fund is expected to be similar to many local mutual funds in the region by having investments in markets from North Africa to the Levant and the Gulf. Another fact that makes it similar to mutual funds is that it will only invest in equity. However, the fund will go long and short on interrelated equities so as to maintain a neutral exposure to the market. Mena capital is upbeat about the long-short strategy in the middle eastern markets as they foresee a bull bubble ready to slow down if not explode. A rapid correction may well be on its way.

The fund managers at Mena capital believe that the real estate and textile markets are overpriced. They have also observed that some individual stocks are overheating because their earnings power and their growth do not justify those valuations. At the same time they also feel that the Egyptian market has come from an extremely undervalued position and is not due for a downturn anY time in the near future.

The fund to modest in its asset base has a lock in period of 2 years. However, investors will be able to invest with only a nine-month early redemption fee of 3%. The fund managers propose to reinvest the dividends arising out of the investments. The fees charged by the fund will be as per industry norms that are 2% management fees and 20% performance fee. The 20% of the ‘high water mark’ uplift of net asset value (NAV) per share will be collected. This means that total increase from last year’s high will be calculated and not just the year’s low to the year’s high. For investors this is quite beneficial as the company is registered in Bahrain where gains are essentially tax-exempt.

Saba is an MS in biomedical engineering, he also enrolled at the University of Pennsylvania’s Wharton School of Business which is one of the top programs in the world. He wanted to launch a biomedical engineering firm in Egypt. However some where down the way he changed course and drifted to finance. Khaled Abdel Majeed is an ex associate of Saba from EFG-Hermes. Business Today Egypt reports:

"Saba says Beltone is also developing 401(k)-style retirement savings accounts for many of its clients; these types of accounts have been slow to develop despite growing demand from the private sector.”

Hedge Fund fees see a downward trend

For years, the hedge funds have been the centre of envy of traditional investment vehicles. Reason: the 20% fees performance fees that the hedge funds charge their investors. This is something that neither the mutual funds nor any other traditional investment company has ever been able to emulate. The hedge funds charge a 2% asset management fees from their investors. Over and above this they are entitled to charge up to 20% of what ever profits that they earn for the investor. This is the profit which the assets amass over and above the benchmark or ‘watermark’ laid down by the fund in agreement with the investor.

This situation is gradually changing. The funds are struggling to justify their share of the profit. Most of this is due to the fact that the hedge fund industry is experiencing overcrowding. Due to this the funds are fighting for the limited opportunities that exist in the market.

On top of this, the institutional investors who are still pouring in a substantial amount of the money are demanding a better deal. Competition is so stiff that the competing hedge funds are even resorting to reducing their performance cut. Approximate average that the funds seem to be charging now a days is around 17.5%.

A research report from BNP Paribas shows that only 60% to 70% of the entire hedge fund market (8000) is charging a 20% performance fee. Another reason for the pulling down of the fees is the over all low performance of the hedge fund industry. Figures are still not out but some experts peg the average return of the industry around 7%. The Telegraph reports:

“Anthony Culligan, at F&C Partners, the fund of hedge funds, said not only were new funds being forced to charge less than 12 months ago, but "funds which have previously been closed have been calling and asking if people want to put more money in".

Yet another case of insider trading by a fund manager comes to light

Another hedge fund manager caught indulging in insider trading. Michael Tom, of Waltham, Massachusetts has pleaded guilty to insider trading charges. He has been charged with five counts of insider trading related to the May 2004 purchase of Charter One Financial Inc by Citizens Financial Group Inc. Citizens is a unit of Royal Bank of Scotland Plc. The acquisition was worth $10.5 billion. Tom has apparently made $743,505 of illegal profits from the deal.

According to Tom’s lawyer, Tom will be entering a formal plea in January. If convicted, he faces up to 10 years in prison and a $1 million fine.

Tom used to work for Citizens unit as a senior analyst till December 2003. He was responsible for examining the banks that Citizens wanted to acquire. He later established a hedge fund as a general partner of GTC Growth Fund LP. The new fund was called Global Time Capital Management LLC. The fund was based in Burlington, Massachusetts.

Tom came to know about Citizens plans to possibly acquire a Cleveland-based bank from an analyst of Citizens who paid him a visit in April 2004. What followed was a buying spree in each of the three Cleveland based banks. This was followed by 52 purchases of stock and options in Charter One in the following days. In early may when the Citizens group announced its intentions to buy Charter One at a premium of 23.7%, the shares of Charter One went up by 22%. Tom lost no time in selling off the securities thereby netting a huge profit.

Now apart from Michael Tom, the analyst who leaked the news of possible acquisition is also awaiting a sentence. Reuters reports:

“Prosecutors said Shengnan Wang, a Citizens analyst and investor in the hedge fund, called Tom on April 29, 2004 and told him that Citizens was conducting due diligence on a Cleveland-based bank that Citizens was about to buy.”   

Want to be a hedge fund manager?

If you thought that hedge fund managers have it easy, think again! The highly secretive world of hedge funds is marred with anxiousness, uncertainty and a lot of fluctuation of blood pressure. No we are not talking only about the investors who have to battle with their fears of not knowing what is happening to their money. We are referring to the racing pulses and midnight sweats that a lot of hedge fund managers suffer from.

Till now we have only seen the money flowing into their bank accounts. We have assumed that their rich and lavish lifestyles will remain no matter what. We think that their limousines, condos and high profile parties are the only life they have seen. Their rich and exotic holidays, and fancy globe trotting, that is so much a hallmark of their existence will remain whether or not the ordinary investor makes profit or not. We may now see that a hedge fund manager’s position may not be that enviable after all.

Barton Biggs is coming out with a book which helps the reader to look beyond the silver curtain. It helps the investor to appreciate the trials and tribulations that this affluent class suffers from. The book which is titled ‘Hedgehogging’ gives a straight situation analysis of hedge fund manager’s problems from a former Morgan Stanley strategist. Biggs who is 71 now is also a burnt veteran player of the hedge fund market.

This book has references to several hedge fund managers who have suffered heavy losses and have shut operations in less than two years. The roller coaster ride was just too much for these managers with who have undergone teeth-grinding existence. You may well ask how this is possible with the kind of high fees that they charge. In fact a lot of references are continuously made by the industry to the fees that they charge. They generally charge 2% management fees and 20% of the profits. This may look like a lot. But remember that the 2% becomes a decent amount only if the hedge funds have a lot of funds under management. We are talking of those hedge funds that have more than a $1 billion under management.

For an average hedge fund startup that has less than $200 million under management, the overheads can take a big bite out of their earnings. They have to pay salaries for analysts and traders, as well as computers and rent. So what they are left with as surplus (if any) is very little.

And if we are talking about the 20% of the profits, please look at how these managers are able to really make any money out of it. In the end of the year, all the profits after expenses are laid on the table and the managers take their share of 20%. Given the recent bleak performance of the industry altogether, how much profit are these managers really making? We are far away from the double digit profits of the yesteryears. Today the hedge funds are merely trying to stay afloat with meager returns. In such a situation, can you think of these managers making a lot of profit?

Having said all this, there is still no dearth of managers who still want to be just here. The pumping adrenalin and the joy of making money keeps them charged up despite all odds. IHT reports:

“A mystique has developed around hedge fund managers, who have become Wall Street's biggest clients and challenge some of the biggest companies - witness Carl Icahn and Time Warner.”   

South Africa witnesses a lot of hedge fund activity

A lot of activity has been seen in the South African Hedge Fund market in the last six months. Though the industry is relatively un-regulated, it is definitely not scaring the investors. It is not even deterring the newer hedge funds from opening shops. Experts in the field are seeing it as an opportunity for newer investors to enter the game.

The older funds are more or less entering their maturity phase. This implies that they will not be able to take on new investors. Later it will also mean that older investors will also no longer be able to invest in them. Therefore the opening of these funds is being seen as a very positive development.

The South Easter Fixed Interest Fund was the first one to enter the fixed interest opportunities category in these six months. It is managed by Alastair Sellick and Jean-Pierre Matthews from PSG Absolute Investments. Clear Horizon Multi-Strategy Fund, a long/short equity fund was launched in October. It has been started by James Gubb and Fred Bouchard. The third fund to hop on to the bandwagon is Badger Quant Strategy Fund. It is managed by Henk Grobler from DWT Securities. The fund utilizes volatility arbitrage on the SAFEX Financial and Agricultural Product Divisions. Money web reports:

“The BESA All Bond Index experienced a particularly strong month, also gaining 2.4%. The sharp increase in the latter was mainly due to our stronger currency, falling oil prices, recent inflation fears subsiding and lower US interest rates.”

UK Pension Funds seen investing in Hedge Funds

The official figures of the extent of involvement of pension funds in hedge funds are out. According to the National Association of Pension Funds about 20% of the large pension funds in the UK have in some form or the other invested in the hedge funds. What it implies is that out of every five larger pension funds, there is at least one fund that has placed its money in hedge funds that have for long been called secretive and not transparent at all.

The report added that some of the pension funds have also increased their allocation to the risky funds. NAPH however found no evidence of any fund having decreased their allocation or having withdrawn their investment altogether. The research report is a compilation of responses collected from 420 pension funds. For long, pension funds have been seen to be testing hedge funds waters. The relatively risk averse category has been consistently been drawn towards the hedge funds in search of better returns and diversity. IPE reports:

“The European Fund and Asset Management Association, EFAMA, yesterday said the European regulatory framework “does not foster a single market for hedge funds”.

Hedge Funds lauded for their role in developing market

Recently Ben Bernanke, Federal Reserve Chairman Nominee appreciated the role that hedge funds play in the market in general. He was responding to questions from Democratic Sen. Paul Sarbanes of Maryland before the Senate Banking Committee. He said that hedge funds have made a big difference to the nations financial system. He however added that they still need to be monitored by the US Central market.

He noted that the hedge fund industry has moved quite ahead of the Long-Term Capital Management days in 1998. The industry today is better equipped to prevent such collapses. More sophistication and flexibility coupled with less leverage makes hedge funds the ideal vehicles for investment. None the less the Fed has to maintain vigil on the banks' involvement with hedge funds. Reuters reports:

“I think it's important not to be complacent. It's important for the Federal Reserve to be aware of what's going on in the market," Bernanke said. "Nevertheless....the hedge fund industry has become more sophisticated…”

The bonus game: Armstrong Study on Hedge Funds and Investment Banking

Every one harps about hefty payouts to the hedge fund managers and Investment Bankers. But how much do they actually get as bonuses? Here are some findings from a study conducted by Armstrong. Armstrong interviewed at least executives from 45 financial institutions over a duration of two months and compiled the findings. Armstrong International is a London based recruitment firm.

The survey indicates that marketers of hedge funds and investment bankers receive the maximum bonuses in the entire financial services market in Europe. Heavy bonuses to the tune of $4 million will be achieved by experts selling interest rate derivatives to hedge funds. These products are also the top income generating instruments. On the other hand, coverage bankers at director level who have diverse product knowledge are slated to receive upwards of $3 million as bonus. 

The two Wall Street firms that are expected to top the list of hefty returns are Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. This year will be their biggest bonus generating year since 2000 chiefly owing to their involvement in corporate takeovers and high debt trading volumes. 

Armstrong however cautions that in today’s scenario, high number of deals will not necessarily mean higher profits and hence higher bonuses. Earlier there were M&A run organizations that did this job but now financing and fixed-income teams seem to be in charge thereby making it very difficult for investment bankers to generate more income now than it was say five years back.

Even companies like Morgan Stanley, Merrill Lynch & Co. and Goldman Sachs have shifted their focus from advising on mergers and acquisitions to a more income generating securities trading and derivatives. 

Though the bonuses are high, it is not lucrative for everyone to thrive. The expectations of a 15 to 20% bonus may therefore seem to be a little far fetched considering the modern financial scenario according to the survey. Bloomberg reports:

“Bankers who can sell products such as derivatives and pension fund advice, instead of only takeover advice, will have the best pay, Kennedy said.”

Pension Funds and Hedge Funds….

Hedge funds are seen as ‘wonder’ money makers of the financial market. That is to say that amongst all the traditional investment vehicles available to investors today, hedge funds make the most money. While this is true, no one can deny the fact that the downside of these risky investments can be quite detrimental as well. Therefore one does not have to be a genius to figure out why the more traditional ‘Pension Funds’ are being drawn to them. Though they have not taken the plunge in a big way they are testing waters by staying on the outskirts. For hedge funds, big institutional investors such as Pension Funds spell increased asset inflow.

However the pension plan investment rules permit only a very small percentage that can be invested in alternative investment funds and as such cannot account for bulk. For instance, in Africa, funds are allowed to invest only 2.5% of their total portfolios in hedge funds. The reason for this is clear. Several hedge funds have gone wrong in the past. Well so have other financial instruments, but the hedge funds are dragged to the gallows primarily because they are quite secretive in their operation.

Therefore funds like pension funds are still a little vary of investing in them. In US too, out of the 158 institutional retirement funds, only five are invested in hedge funds as on date. However this equation might soon change with more and more pension funds wanting to take the plunge soon. It is estimated that over 100 pension plans will start investing in hedge funds say in the next 3 years.

Some of these observations were made by Simon Peile of African Harvest Alternative Investments. The lure of hedge funds does exist, but he warns that the investors should be wise in selecting their hedge fund and not opt for the first hedge fund that crosses their path. Money Web reports:

“Simon Peile of African Harvest Alternative Investments makes a compelling argument for a portion of your retirement fund to be invested in a hedge fund. The returns, he says, are better than other asset classes, but also with less downside risk.”

US and hedge fund frauds

US has been declared as the biggest haven for hedge fund frauds. While the hedge fund market in the US may be the largest, so is the number of instances of fraud. It might be a good idea to get into reasons behind these frauds and why they are so many when compared with say Europe.

The key differentiator is the difficulty that a prospective hedge fund manager has to face in order to start a hedge fund in the country. In the US, there are not very many restrictions on starting a hedge fund. Almost any body can open one. This scenario may however change soon with the SEC implementing its regulations in Feb next year. Even after the regulations are put into place, the instances of fraud may not come down phenomenally. The reason for this is that the SEC will require only those fund managers to register with them who manage more than $25 million of investor money. This observation was made by Alternative Investment Management Association (AIMA), an industry group based in London.

Compare this with the scenario in UK where there are stringent entry qualifiers for a hedge fund to start operations. The industry there is regulated by Financial Services Authority (FSA). FSA requires that even before the funds start taking up clients, they are required to register with it. It also carries out a thorough back ground check on the fund managers and their ability to manage the funds. They look into the track records and history of the backers before giving a green signal. To drive home this point, Christopher Fawcett, chairman of AIMA commented that FSA makes sure that the prospective hedge fund managers’ experience has been in a similar field. He or she for instance cannot be a librarian and start a hedge fund. Mr Fawcett is also manager of Fauchier Partners,a fund of funds, based in London with about $4 billion in assets.

To drive home the key differentiator, Florence Lombard, AIMA's executive director said that in the past 15 years that AIMA has existed there has been only one registered hedge fund fraud case. Compare this with around 20 registered with SEC in US in the last one year itself. Even if you give them the benefit of being a larger market, the number of hedge fund frauds over all are simply unforgivable.

AIMA is therefore wholeheartedly supporting the process of regulation in the US. However it is demanding that the funds that are registered in Britain should not be required by US to register there as well. FSA’s process of elimination is quite stringent and if the overseas hedge funds from Britain have to necessarily register with SEC there might be quite a few drop outs. This would ultimately translate into the overall industry suffering.

Read more on the topic in a write-up on CNN Money.

Hedge Funds experienced severe October blues this year

With the results of October in, one thing is clear – Hedge funds faced they toughest time in recent times. October generally is known for struggling times but this year was particularly bad, industry observers feel. In fact what is being said is that apart from Japan, there is no other market that can boast of an even market condition. The environment was tough even on the stock and bonds market. Every one was badly hit, irrespective of the strategy they used.

Traditional long/short stock funds were the worst hit with some funds experiencing a decline of 8 to 10 % in the month. For example, The Cantillon World Ltd. was down about 3%. Cantillon is a consistently top performing global long/short equity fund with offices in New York and London and is run by former Lazard Asset Management star William von Mueffling. Atticus Capital's Atticus Global Ltd. fund lost more than 10 %.  $1.5 billion AlphaGen Capella fund, a known strong performer again, was down 3.5 % for the first three weeks of October. Therefore, funds that held long positions in energy stocks in particular got hit badly while the broader market struggled. Industry experts feel that US hedge funds were the worse hit in the category primarily because of short-term interest rates have been rising for more than a year now.

Even Arbitrage funds took a beating in October. Arbitrage funds attempt to rake in profits by selling and buying separate but related instruments and profit from a difference in price. Some arbitrages felt the pressure of low volatility in the market. They went ahead and ramped up their exposure to the credit markets and got hurt due to bad timing on their part.

Another factor that brought down the performance of the hedge funds was the meltdown of commodities brokerage Refco. Refco filed for bankruptcy after it its chief executive Phillip Bennett was charged with securities fraud. This led to customers withdrawing their assets and hence the current situation. Several hedge funds bore the brunt of the situation.

But however grim this may sound but industry gurus feel that the worst for the year may be over. With two more months for the year to end, the fund will jump back. In fact they are even suggesting a rally in December which is expected to carry on till about the second quarter of 2006. CNN reports:

“According to Chicago-based hedge fund tracker Hedge Fund Research, its index of 1,600 funds gained 5.6 percent in the third quarter, most of the 7.3 percent it estimates hedge funds have returned this year through September.”

Why are there so few ‘Women’ hedge fund managers?

This one is in for a massive debate both in the board room as well as on dinner tables. The question we are attempting to answer is ‘why is the number of women in the hedge fund industry so low?’ A key question indeed, when one sees women at par with men in almost every thing around us – Doctors, lawyers, scientists, engineers, VJs, academicians and the likes. Why is it that the hedge fund industry is so blue and with such few pink dots to liven it up?

It is incorrect to say that women lack the talent or the intelligence to manage a hedge fund. They have oodles of that – not talking the feminist way!! ‘Propensity to take Risk’ – perhaps this might be a small part of the puzzle. Women are more process oriented, methodical and good at picking up all the strings. The last point in particular is of critical importance since in the process of finding out ‘what is amiss?’ or ‘what is the downside of a particular action?’, some degree of spontaneity may be lost. And hedge funds are to a great extent a game of ‘quick reflexes’. But then one might argue, even surgeons need to take quick actions in order to revive a ‘sinking’ patient and there are a large number of top class surgeons in the world. Does this argument still hold good?

One argument is with respect to the demand and supply. According to some surveys, only a third of the students pursuing management in any B-school are women. Out of these, not many take up finance as their major. On top of this, the number of women who survive the pressures of investment bank, particularly in areas like trading, quantitative work, or fixed income are relatively low. This essentially is a launch pad for several hedge fund managers and the reality I that if you are not here you can very rarely be part of the hedge funds industry. This observation was made by Patricia Young, chief investment officer of NewMarket Capital Partners, a fund of funds.

There is another explanation which has it’s origin from study of ‘buyer behavior’. People tend to buy from a person they are generally comfortable with. This point is highly relevant when one is making a big item purchase which requires a sizable part of his earnings to flow into the purchase. This is something that marketers call ‘High Involvement Product purchase’. Hedge funds, one would agree fall in the same category. Men and women alike have showed apprehension (in varying degrees) when asked if they are fine with a woman money manager, managing their money in a hedge fund. So you see that even the women are uncomfortable of trusting their own lot when decisions like investing money is concerned. 

Then there is this point about women being ‘attracted’ to the field. Fund managers have repeatedly said that even if they were specifically looking out for women to hire, the number of women applicants is just a fraction of the résumés that come up for consideration. So perhaps the key lies in the ‘attractiveness’ of the field!

And then there is this feminist approach that is likely to get the ‘women-lib’ in action. There are some who say that you cannot manage a fund and raise children. What is thereby being suggested is that demands made by the industry are not compatible with family life. This might sound like a week accusation of why women are unsuited for the job. People in favor of the ‘skirt brigade’ say that actually they might it may perhaps be more compatible with family demands than investment banking or consulting, where you might have to fly off to say Japan at the drop of a hat. While some key pointers form part of this write-up, the debate continues.

For more read article on this issue on Fortune.com

Why Hedge Funds do not want to go public: An insight!

Can past be an indicator of how the future can or will be – well that’s a question no one can answer today and especially so with respect to hedge funds. Hedge funds have grown enormously in the last decade and a half. Heady double digit returns have led several cash rich investors and institutions to pour more and more funds into this industry.  While the quantum of assets being managed is increasing even today, the returns have ‘plateaued’.

But the industry’s name still has some luster left. This has led to some hedge funds going public. The hedge funds in question here are - Man Group Plc and Rab Capital Plc. Industry analysts are skeptical about the business being lucrative and also about the prospects of more hedge funds following the example. They argue that what is most important is the quality – of – earnings which is currently nothing to write home about. Even non glamorous industries like plumbing supplies or even Internet poker would perhaps show better prospects. Therefore there may not be much scope for growth left in the industry. 

While the reputed money managers continue to move to the much sought after industry, apprehensions about its continued brilliant performance plague the hedge funds industry. The point being raised is the justification about the remuneration that the fund managers are receiving today. Total compensation of Edward Lampert, chairman of Greenwich, Connecticut-based ESL Investments Inc for instance crossed the $1 billion mark. Institutional Investor's Alpha magazine indicates that average earnings for the top 25 executives in the industry has risen by 21 percent to $251 million today.

Where is all this money coming from? From the high management fees and of course the performance bonus. This obviously impacts the total quality of the earning of the funds. Direct impact on the P/E ratio is a logical consequence.

With higher returns, one would assume that the funds are really making a lot of money. But one look at the P/E ratios of Man Group shows that there are others who are faring much better minus the fanfare. Man Group trades at a historic price-earnings ratio of 14 and a prospective ratio of 11. Compare this with the rather humble non flashy Wolseley Plc, a U.K. plumbing distributor, trades on a prospective P/E ratio of 12.

Also the fact that a hedge funds’ success lies squarely on the shoulders of the lead fund manager makes matters worse. A star turns into a ‘good for nothing’ overnight the moment the fund manager calls it quits. This makes the funds quite vulnerable to the downturns. 

All these arguments perhaps would explain as to why very few hedge funds have gone public, even though they have been generating dizzy profits.

Read some more on this on Bloomberg.com

Stake holder list of now bankrupt Delphi

Delphi, the world's largest auto parts manufacturer, filed for bankruptcy recently. Along with it came down assets of several hedge funds. Delphi has been threatening bankruptcy for some weeks before it actually got down to actually doing so. Just over a week before it actually filed for bankruptcy, its shares were trading around $2.99. On the day that the firm filed for bankruptcy, its shares were trading at a mere 39 cents. Following the filing, the trading of Delphi shares was suspended.

One of the largest share holders of the firm today is 52 million shares Partners. With 52 million shares, Appaloosa Partners control about 9.3% stake in the company. Appaloosa is a New Jersey based hedge fund which specializes in investing in distressed companies. Delphi is its 14th largest holding and apparently accounts for 1.1% of its portfolio. With over 9% stake in the company, the fund is now the second largest stakeholder in the company. 

The fund recently made a disclosure of its stake to SEC. It however did not reveal as to when or at what price the shares had been purchased. Its president, David Tepper was the former head of junk bond trading at Goldman Sachs.

Other funds/companies that are prominent shareholders in the now bankrupt company are Capital Research & Management Company with 12.8% stake and Dodge & Cox have at least 48.6 million shares. Apart from them, TIAA-CREF Investment Management owns 26.5 million shares of Delphi. Money.cnn.com reports:

“It also said that Appaloosa is now the No. 2 holder of Delphi stock, behind only Capital Research & Management Company, which manages the American Funds family of mutual funds.”

Hedge funds not influencing very many M&A deals: JP Morgan

There has been a lot of smoke about hedge funds being involved in pushing merger and arbitrage deals across Europe, mostly without a major fire. This observation was made by Klaus Diederichs, head of European investment banking, J.P. Morgan. Diederichs said there have been instances of some hedge funds being involved in pushing board rooms to change their management strategies but the quantum is really small.

Speaking at the Reuters Corporate Finance Summit, he added that there has been a Deutsche Boerse case and then the news about German-U.S. carmaker DaimlerChrysler where hedge funds were involved. Apart from these there have not been any major moves in the market. He however noted that Hedge funds did act as additional providers of liquidity essentially in corporate transactions to players such as private equity firms. Today.reuters.com reports:

“J.P. Morgan's Diederichs, however, told the Summit at Reuters' London headquarters he had not seen a major move by hedge funds into flexing their market power to influence European company boards”

Hedge funds activists: Boon or bane?

Who ever said that hedge funds are ‘locusts’ thriving on the shortcomings of companies already struggling has a lot of argument against him. There has been a spike in the overall performance of these companies thanks to hedge funds that take on the role of share holder activists. The recent conquests of Carl Icahn ‘The Corporate Raider’ have motivated more inflow of hedge fund money.

His prize winnings include Temple-Inland, Kerr McGee and, Time Warner. Hedge funds are almost acting like a guiding conscience preventing major business follies. Acts like that witnessed during hedge funds preventing an ill-advised take over bid of the London Stock exchange by Deutsche Boerse are examples of how the hedge funds can make a difference. 

There are other examples like Pershing Square's Bill Ackman pushing McDonald's to manage its balance sheet more efficiently and increase shareholder value. Eddie Lampert on the other hand, took complete control of Kmart and Sears altogether. Randy Cohen, finance professor of Harvard Business School described it as a kind of hostile takeover albeit a small one.

The supporters of shareholder activism argue that CEO of these mismanaged companies need to part with the surplus cash that they have. The money is not earning anything and as such there is no value being returned to the share holders of the company. They argue that with so much cash at their disposal, it is quite easy for them to invest irrationally. And this is where the ‘corporate governance’ by hedge funds make a difference.

But what has to be considered here is whether the role of hedge funds as activists is to serve own interests better or push for over all betterment of the company as well as the stake holders. There is no dearth of hedge funds with short term focus. Once their interests are taken care of, they exit, leaving the company in a worse state than in which they entered. Read more on this on Post-gazzette.com:

“And that's what this wave of hedge-fund agitation is about: They want companies to pay out their cash or take more risk. For one thing, companies don't have nearly enough debt.”

Hedge funds grows by over 30% in 2005

2005 has been a mixed bag as far as hedge funds performance is concerned. Not to mention the fact that there have been more lows than ups this year. This has also been year that has seen several hedge fund scandals. An of course, a year which gave a less than average return on assets to investors. Despite all this, the money never stopped coming into this indomitable investment tool.

At the end of 2004, the net assets handled by individual fund managers of hedge funds stood at $1 trillion. Today this figure has crossed $1.3 trillion. Apart from this, the total holdings of funds of hedge funds today stand at $709 billion. These are figures at the end of September 2005. With the inflows of the last quarter still to take place, who knows what the final 2005 figure be.

This eye opening revelation was made after collating data from 44 hedge fund administrators, and is mostly based on figures at the end of September 2005. Earlier predictions have indicated that the industry will grow at the rate of 15% till at least 2008. By the industry size increasing by 30% in less than a year, one thing is for sure – the industry is healthy and kicking. 

Another key finding is that the Asian market is the one from which future fund inflows will occur in the near future. As of now, the area accounts for only 5% of all assets in these portfolios. Money.cnn.com reports:

“Hedge funds have seen a run of mixed performance over the past year, with returns squeezed by a lack of volatility and clear trends that these investment pools need to make money.”

FSA advices institutions to do their own due diligence before investing in hedge funds

In February 2006, US hedge funds will have to follow some rules specially those pertaining to them being registered by SEC. This is a land mark move and perhaps will pave a way for further controlling the previously unregulated industry. Now the question that is being asked is whether rest of the world will follow suit?

Recently Tom Huertas, head of wholesale bank regulation of Financial Services Authority (FSA) brought up this question yet again. He was speaking at the Reuters Corporate Finance Summit. He said that the existence of hedge funds in the financial industry was a very positive development of our times. It offers investors with a broad range of investment options. For institutional investors in particular this seems to be a good way to boost returns. But they should never forget that the industry is known for its unpredictable nature. They stand to loose every thing if they are not cautious. Therefore they have to carry out their own due diligence before taking any step in this direction.

He reminded those gathered that in its June discussion paper, the Authority had outlined some of the risks hedge funds pose. These risks included erosion of confidence, disruption of liquidity and challenges in valuing portfolios. There is also a paper that highlights the reservations of the authority especially in context with the funds being sold to individual investors.

The FSA mandates that all hedge fund managers in London register with it. But a tight control over them is currently not possible since most of the hedge funds themselves are registered in offshore centers such as the Cayman Islands that offer privileges like low-tax and light regulation. Today.reuters.co.uk reports:

“Institutions such as pension funds should carefully check out the hedge funds they invest in and understand that they may be risking their capital if a fund collapses, the Financial Services Authority said.”

EU financial stability may be under threat from hedge funds: ECB

Chairman of the ECB's Banking Supervision Committee, Edgar Meister indicated that the rapid growth of the hedge funds industry may adversely impact EU’s over all financial stability. He pointed out that the threat really comes from the creditors and counterparties (implying banks) of the hedge funds. He was presenting the ECB's annual report on banking stability.

He said that while the risk exists, it is important to know that today most banks dealing with hedge funds have advanced risk management standards. However, the ‘opacity’ of the industry cannot be ruled out. This lack of transparency of hedge funds adversely affects the banks' ability to aggregate their exposures to hedge funds' and hence some monitoring may be required. During the presentation, he also added that even the private equity funds can pose a new type of risk and is something that may require monitoring as well. This is so because the usual high leverage on loans secured by funds can increase banks' exposure to them. Forbes.com reports:

“In the short term, the overall outlook for banks in the euro zone is 'broadly positive', with short term conditions looking 'fairly robust' in most EU countries. But in the medium to long term, high oil prices and large global imbalances may pose a possible risk for the banking sector”

Hedge Funds in South Africa: Small but promising!

The Hedge fund industry is spreading its tentacles every where and South African market is no exception. Though the percentage of investment of hedge funds in South Africa is very small in the overall investment market, its future is bright. Simon Peile, head of African Harvest Alternative Investments, commented recently that today some of the larger retirement funds have started to make allocations specifically to hedge funds. Therefore one can be optimistic that in future hedge funds will not only survive but develop well.

Commenting on the issue of occasional frauds rocking the financial community every now and then he said that when the industry itself is so large, such instances are bound to happen. Judgment regarding their workability or sustainability should not be passed loosely. With particular reference to the Bayou Management collapse, he said that such cases should serve as eye openers for investors. Investors have to do their homework before they take a plunge into the field. Bayou fraud occurred because the fund was not using a third party custodian, and a third party administrator. This is an absolute must for a strong hedge fund with a clear conscience. He added that in South Africa most of the hedge funds have proper distribution of duties with third party professional administrators.

People tend to ask questions such as when is the right time to invest in hedge funds, this according to him is an inappropriate way of addressing the question regarding timing and hedge funds. Hedge funds have to be seen exclusively as a way of reducing the overall risk in one’s portfolio.

On the question of whether hedge funds perform better in a bull phase or a bear phase, his response was measured. He said that the hedge funds are structured in such a way so as to give returns when the equity market is going down and on the other hand it can loose money when the market is doing exceptionally well.

Next he addressed the issue of retail investing. He said that right now retail investing into hedge fund is not well developed. The main reason for this is lack of regulation. However, as soon as hedge fund investments will fall under the Collective Investments Schemes Act situation will change. For now retail investors have to be contended with investing in endowment policies that invest in hedge funds. These policies have lock in periods of varying length for say up to five years. Investors should not mind this, as the over all risk to their investment is being minimized in the bargain. As it is, he feel that Hedge funds should be seen as a long-term investment. If one sees the instrument as merely as a market timing exercise he may be in for trouble.

Read the complete transcript of the conversation on Transcripts.businessday.co.za

How will 2005 end for hedge funds?

The prediction game of how the current year will end has already begun. The quarters that went by were not spectacular by any scope of imagination. If one compares the returns of the hedge funds of 2003 or even 2004 with that experienced this year, he will see a story of dismay emerging. The year started on a Luke-warm note and the second quarter was a washout. Quarter three did however help the industry to gain feet but then under the current market scenario, experts are not expecting a miracle out of the last quarter.

Analysts feel that that the long/short equity funds that take long and short positions in stocks will in particular end the year with mid-single digit percentage gains. Unlike the last year, a 4th quarter rally cannot be expected to repeat itself this year. 

Larry Smith, the chief investment officer at Third Wave Global Investors adds that though the performance in comparative terms is not so encouraging, the over all picture is not so grim. He states that hedge funds are still outpacing the broader markets in the current year. Even in a market which has been offering less volatility, most of the major indexes have given returns in the range of 5 to 7%. For instance, Hedge Fund Research, a Chicago-based hedge fund tracker of 1