Hedge Fund Street

A Rose By Any Other Name…

A rose by any other name…? I don’t think so. There are some people who believe that hedge fund industry wouldn’t have to undergo all the trouble that it’s been through if only it changed its name. Rather engage in a major re-branding campaign.

The problem why hedge funds are so universally disliked is that most people don’t understand them. And it is natural human tendency to hate, be suspicious of or dislike something you cannot understand. So what this industry needs is an extreme makeover… so, let’s begin with the name – a misnomer if you ask me. In what sense is the industry hedged?

Hedge funds are private-investment pools that are open to a limited number of extremely rich participants. These pools invest in almost anything. This encourages creative management strategies, which are unavailable to other, more regulated funds. Coming back to my question, how can this strategy be termed as hedged in any way?

Agreed, the media too hasn’t been fair to the industry and has given it a lot of bad press. The media has made it seem as if the entire industry just wallows in wealth, exploit the market, and making life hell for the little guys. Probably what this industry needs to do is firstly, get together and create a united front. Next, they should go on a publicity blitzkrieg. They basically need to re-brand their product if they want to survive in the long term.

The Returns Story

Long timers must’ve noticed that hedge funds are increasingly being structured more like mutual funds. Investment strategies that depend on long-only equity have allowed more institutions to expect a fixed rate of return on their investments annually. However, the downside of this effect is that despite hedge funds resembling mutual funds, their fee structure is still on the high side.

Most hedge funds employ a two-and-twenty fee structure wherein the hedge fund manager gets 2% of the investments to operate the fund for the first year plus 20 percent of the upside of anything he earns. This fee structure often leaves small investors with returns no greater than, or sometimes less than, returns on mutual funds.

Painful Problem Of Paying Your Hedge Fund Manager

I personally don’t do hedge funds – just cannot afford them you see. But if you can and do, then it must be pretty painful to watch your hedge fund manager buy himself yet another super luxury yacht or the nth vacation home in some exotic location. After all it’s YOUR money. Well, so they are making their billions and there’s not much you can do about it. Even if the fund hasn’t performed all too well. And that is what irks.

I mean I can understand if a fund manager can turn your money around and give you fabulous returns AND then ask for his pound of flesh. But if s/he takes his/ her pound of flesh even if the fund hasn’t done too well, I’d call that greed. What says? For instance, there was recent news of how hedge fund manager Sloane Robinson showed the top-earning partner made more than £58m in the 16 months to March 2006. and the worst part? Well these guys want to keep the whole thing hush-hush.

But how can you be so secretive when pension funds start investing in hedge funds. These funds are answerable to their investors so they have every right to know where their money goes. So it is in the hedge fund managers’ best interests to begin earning those grotesque figures.

Read This Before You Invest

Are you wealthy enough to put aside a sizeable amount to ride the hedge fund wave? Well, then you probably want to invest in hedge funds. Before you take the decision to invest, there are a few things you need to know.

For instance, it is very important to know about the manager of the hedge fund you want to invest in. You must learn about the credentials and experience of the fund’s founders and principals. You don’t want to get stuck with a fund that sinks thanks to the inexperience or greed of your fund manager do you?

Next, try to understand the level of risk involved in the fund’s investment strategy. There are a wide variety of investment strategies available to hedge funds today. The risks corresponding to each strategy vary greatly and hence it is important for you to understand the aggressive or conservative nature of your fund’s strategy. This will help you determine if it meets your investing goals and tolerance for risk. Find out if your hedge fund manager follows any set of standards and a code of conduct.

Next, check the fee structure and how much of the money goes to the manager. Most hedge funds charge a management fee of around two percent and a performance-based fee of 20 percent. The fee structure for fund-of-funds is different.

One thing you must realize is that unlike mutual funds, hedge funds are more of illiquid assets. This means that while mutual funds can be bought and sold with relative ease, hedge funds limit the opportunities to cash in shares. They may also impose a lockout period during which time you may not be allowed to redeem your shares after an initial investment.

And the most important thing you must determine is if hedge funds fit in with your investment strategy and long-term growth plans. This means you must fully understand the structure and attributes of the vehicle in which you plan to invest.

Hedge Funds Fail The Returns V/s Fees Test

Now this is definitely not ‘news’ news. I mean if anybody actually went “Wow!” when they heard that hedge fund returns don’t justify their fees, the only reason would be that s/he’s been out in the woods for a very long time. The fact that hedge funds charge too high fees and earn modest investment returns is a well-known fact. What I’d like to know is what the industry and investors plan to do to rectify this issue.

According to industry executives there is a problem of plenty in the hedge fund industry. These hedge funds get paid outrageous amounts of money to produce mediocre returns. Most hedge fund managers don’t even clearly articulate a strategy to clients. They just expect clients to lap up whatever they offer.

Industry estimates show that there are around 9,000 hedge funds controlling up to $1.7 trillion of assets. These funds typically charge 1 to 2 percent management fees and up to 20 percent performance fees. This is much more than that charged by traditional mutual funds.

Data collected for 2005 shows that the average return for all hedge funds was about 7.6 percent. This compares unfavorably with the 10 percent rise in global stock market returns. Pension plans and other investors have been pouring money into hedge funds, swelling the market and diluting many funds' returns. As a result, more funds are likely to disappoint investors by making only single-digit percentage returns in future years.

New Renaissance Hedge Fund May Be Plateauing Off

Too much success is a difficult thing to handle. News has it that Renaissance Technologies Corp., a top-performing hedge fund has decided to close its doors to outside investors. The hedge fund firm, which has quadrupled its assets to $16 billion this year, wants to better manage its flood of money.

The main reason for this decision is that Renaissance suddenly finds itself in a piquant situation. The returns are historically high no doubt but these incredible returns are being dampened. The reason: too much money in equity strategies at the Institutional Equities Fund. So, they found a great solution. They decided to limit capital from investors, as they don’t want to "take in too much too quickly." Reuters.com reports:

The Renaissance fund, which employs mathematical "quantitative" strategies to rapidly trade only U.S. equities, was billed at its inception last year as being able to successfully generate returns on $100 billion, which would make it by far the largest hedge fund. But few in the industry expected the new fund to reach anywhere near that amount. And while some month-to-month swings are to be expected from any hedge fund, recent returns suggest Renaissance might reach its optimal size well below $100 billion, experts said.

Read more: New Renaissance hedge fund may reach limits

Goldman Sachs Takes Amaranth Traders Onboard

I really don’t know why I’m still tracking Amaranth… probably it’s some kind of morbid fascination. Well, the latest I heard was that Goldman Sachs is reportedly hiring a team of 17 traders from Amaranth Advisors to beef up its alternative-investment unit. Thestreet.com reports:

The investment bank wants the group, led by former Amaranth trader Gregg Felton, to develop credit-trading strategies, according to The Wall Street Journal, which reported the hiring, citing people familiar with the matter.

Read more: Goldman Sachs Hires Amaranth Traders

Managers Play Games With Hedge Funds

It is quite easy to understand why established fund managers with good track records in the retail market are enticed by the lucrative fees of hedge funds. However, now there seems to be a reverse flow of talent. Citywire.co.uk reports:

At the start of next year James Elliot will rejoin JP Morgan to run long-only Japanese money after a one-year stint at RAB Capital. This follows last year’s news that Gary West and James Inglis Jones, who also used to run money at JP Morgan, are returning to traditional fund management with Liontrust after a spell managing hedge funds at Polar Capital.

Read more: Frontrunner: Hedge fund traffic no longer one way

December Is ‘Let’s Invest In Hedge Funds’ Month

If you are wealthy enough, now’s the best time to put your money into hedge funds if Citigroup Private Bank is to be believed. Citigroup studied nearly 16 years of returns among the popular alternative investment, and noted that December is the best month for hedge funds. Reuters.com reports:

The average monthly return for the asset class over the period has been 0.92 percent. December, however, has brought in around 1.5 percent. January has average returns of more than 1.1 percent, slightly less than March. "Average hedge fund returns during the turn of the year (December and January) are almost 1.5 times ... average returns during the rest of the year," the private bank's investment analysis and advice group said in a recent presentation.

Read more: Citigroup Sees Turn of the Year Hedge Fund Bonanza

Take Me Home Hedge Fund Roads, Take Me Home

One thing you’ve gotta hand these Canadians – they think up very unique ideas to maintain their equilibrium. And I mean this with all due respect. I mean, I loved the way they handled the payday loan industry – soft gloves and hands of steel approach was the perfect way to keep these guys in their place.

And now, the provincial government in Nova Scotia has found a unique way of keeping business graduates from moving out. The province plans to give $9.1 million in payroll rebates to Bermuda-based hedge fund management firm, Butterfield Fund Services, if it creates and maintains up to 400 jobs over the next seven years. Butterfield’s investment in Nova Scotia is expected to attract more like-minded financial service businesses. This would eventually create even more opportunity to retain talented graduates and even bring seasoned accounting professionals back home to Nova Scotia. Big plans indeed. Thechronicleherald.ca reports:

Frank Sebestyen, senior vice-president and group head of Butterfield Fund Services, said the company will be looking for local employees with accounting training and experience. "What funds need. . . is a broad range of service providers," he said, including investment managers, technology service providers and administrators, whom he said would be paid competitively. "You really have to have an accounting background."

Read more: Hedge fund firm setting up in N.S.

Funds With A Heart

And you thought hedge funds were all about making money and more money. Did you know that the Children’s Investment Fund, better known as TCI, has a charitable arm that distributed more than $2.3 million to international health and development causes, according to its 2005 United States tax returns? Nytimes.com reports:

Mr. Hohn and his wife, Jamie Cooper-Hohn, who runs TCI’s foundation, took a different tack: they are using a portion of the fees generated by the hedge fund to finance the foundation and thus donate to charity.

Read more: A Hedge Fund With High Returns and High-Reaching Goals

Do We Need Jugglers Or Managers?

Is your money manager ignoring you? It is a possibility if your manager is one of those guys who are today juggling multiple roles. These managers handle everything from plain-vanilla mutual funds for small-time investors to hedge funds for wealthy individuals and institutional investors.

There is a fear that such a trend could lead managers to favor hedge fund investors. It is obvious isn’t it? These are the guys with the deep pockets and they pay much more than a mutual fund investor can or should. While some experts believe that there is no harm in such management, I personally have my doubts. I mean how can anybody be impartial when there is such a huge difference in the fee structure?

Hedge funds usually charge a certain percentage as management fees. This comes to around 1 2 percent. In addition to this, there is a 20 percent performance-based fee. In contrast to this, an average domestic stock mutual fund charges a management fee of roughly 1.5 percent. For any of those juggling managers, paying more attention to the hedge funds would be natural. The hefty performance-based fees are definitely a great incentive. So what exactly could they do to increase hedge fund returns? They could allocate their best investment opportunities to hedge funds.

The flip side of this argument is that good managers need an incentive to stick on with mutual funds. It is definitely a fact that in the recent past, many managers left mutual-fund firms for the bigger paychecks and lighter regulation of the hedge fund world. So, if you have a good manager then it makes sense to hand over the carrot of hedge fund fees so they manage mutual funds also. Not a bad argument.

But I think we are kidding ourselves if we say these managers are gonna be fair to mutual funds. They left the mutual fund industry because of low fees. So what’s stopping them from ignoring their mutual fund portfolio while juggling as well? And you know what all this makes me think? If such managers got something better than hedge funds, wouldn’t they ignore us hedge fund investors as well? I don’t know if I’m gonna be comfortable with such a guy. How about you?

Fund Of Funds Lack Luster, Complain Investors

I always thought that fund of hedge funds would be the mutual funds of the hedge fund industry. They would be reliable and would ensure decent returns to investors. So, the fact that investors were unhappy with these fund of funds, just didn’t sound right. But then if you don’t perform, even a monarch will face pressure from his/her subjects, right?

Investors want these fund of funds to demonstrate their investment value. Recent disappointing performances have made investors re-assess the value proposition offered by fund of hedge funds, according to a Fitch report. Many investors are even wondering whether it is worth paying an extra layer of fees only to experience a disappointing performance. The main reason is that funds of hedge funds have been unable to effectively diversify their risks. Investmentexecutive.com reports:

“Funds of hedge funds now face increased competition, greater scrutiny from investors and are increasingly constrained by limited capacities and a higher correlation of hedge funds,” says Aymeric Poizot, director at Fitch.

Read more: Fund of hedge funds face investor pressure due to disappointing performance

Protecting The Human Face

I’ve talked so much about the Amaranth collapse and its aftermath, and the logistics involved. But somewhere along the way, I forgot the human face – the investors. What can you do to avoid losing your money in a hedge fund collapse? Firstly, ensure that no more than 10 percent of your asset total can go into a single hedge fund. And no more than 35 percent of all your assets should be placed in hedge funds.

This would force hedge funds to "know YOU – the customer" that much better. It would also diversify investors. This would also would allow regulators to keep the bulk of their focus on those investments that are common tools for average investors.

Outsourcing Of Hedge Fund Functions May Provide Transparency

To cut costs and improve the service to clients, hedge funds have of late been outsourcing certain key functions. These functions include confirmation of over-the-counter derivatives trades, reconciliation of trades done across multiple prime brokers and daily profit and loss reporting. Financialnews-us.com reports:

The shift is likely to provide the Securities and Exchange Commission, the US regulator, with more transparency about trades done by the estimated 8,800 US hedge funds. Third-party providers will supply verification of a hedge fund's assets - something that was lacking while hedge funds kept the middle office in-house.

Read more: Hedge fund transparency

It's A Win-Win For Securities Firms

The debacle at Amaranth has not prevented the biggest so-called prime brokers, like Goldman and Morgan Stanley, from continuing to reap a bonanza in 2006. Securities firms are poised to earn about $8 billion on prime brokerage services to hedge funds. IHT.com reports:

"It looks like there has been no fallout for the prime brokers," said Michael Holland, who manages the New York investment firm Holland & Co. Amaranth "makes those businesses look much more attractive, rather than less attractive," he said.

Read more: Wall Street giants dodge hedge fund's debacle

Better Than A Hedge Fund

Since I’ve written about hybrid mutual funds and how you can invest in them, I think I have stoked up enough interest in this particular product. So, I guess it is time to elucidate on the subject. Firstly, let us look at certain figures I got of the web: Diamond Hill Focus Long/Short, one of the best performers in this type of fund has returns of 17.93% and 9.93% for three and five years, respectively.

How do they manage such returns? Well, they invest in all kinds of market with the ultimate goal of making money even in the case of a meltdown. Another good thing about these funds is that they strive to get absolute returns – but herein lies their greatest weakness. This need for absolute returns makes them especially volatile. So if you don’t have the stomach for such returns, you’d do better to stay away from these funds.

Like any traditional fund, a hybrid fund also own stocks or bonds. What’s different is that they may also bet on share prices falling by using hedge fund techniques like "shorting" stocks. This earns them profit from declines in the stock market. So why should anyone go in for a hybrid mutual fund instead of a hedge fund? Here’s why:

• Any hedge fund has an entry fee of at least $1 m. Not everybody has that kind of disposable money. Hybrid funds require you to pay around $25,000.
• With a mutual fund, you have access to the net asset value of your fund on a daily basis. This means you can add or withdraw money daily. This facility is not available with hedge funds, which usually have longer waiting periods during which you cannot get your money. So liquidity is at a low with hedge funds.
• Another big advantage is that with a hybrid mutual fund, you may have to pay hefty annual fees, but you will not have to give the fund a cut of your profits – whereas with hedge funds, you may have to shell out not only a fee, but also around 20% of any profits. There are more benefits, which I will write about later.

Henderson to Launch Fund Of Its Own Funds

Fund firm Henderson has plans to launch a fund that will invest in a range of its own hedge funds. The Henderson Total Return fund will launch on September 1 and be managed by Bill McQuaker, Director of Multi-Manager Funds. Reuters.com reports:

The minimum investment will be $100,000 (52,000 pounds). The fund, which will be domiciled in the Cayman Islands and listed on the Irish Stock Exchange, will be aimed at institutional investors, high net worth clients, private banks and family offices.

Read more: Henderson to launch fund of internal hedge funds

Hedge Funds: Boring & predictable

Common belief is that hedge funds are supposed to make money the risky way so why is it that hedge fund managers are now fighting shy of taking risks? Their argument is that their customers don’t want them to deal in such investments. So, for fear of losing these customers and more importantly, their fees, which can only be called exorbitant, hedge fund firms are now learning to play safe.

This sudden change in what is essentially a risk-taking business came about slowly. The sector's profile witnessed a change after institutions poured money in and drove worldwide hedge fund assets to more than $1,000bn. This large amount of money has weighed heavily on hedge fund performance and has led to ‘overcrowding’ in many strategies. As they reach critical mass, these firms begin to slowdown their aggressive activity and try to appease their major clients.

When Hedging Can Be a Big Risk

Its ‘value at risk’ (VAR) models are the pride of the hedge fund industry. However, last month, traders say, some markets witnessed six times the expected range of volatility and the worst part was that the fancy VAR models, based on past experience, failed to predict the actual damage. Washingtonpost.com reports:

The European Central Bank got so worried that it warned this month that hedge funds were the financial equivalent of bird flu and could pose a "major risk for financial stability." And Raghuram Rajan, the chief economist of the International Monetary Fund, cautioned June 8 that hedge fund managers were all chasing the same investment magic they describe as "alpha." This was driving them like a herd into riskier assets and making them all vulnerable to the same potential reversals.

Read more: When Hedging Doesn't Pay Off

CalPERS Adds to its Hedge Fund Portfolio

Richard Breeden's activist hedge fund firm Breeden Capital Management, was recently allocated $400 million as part of the California Public Employees' Retirement System's (CalPERS) corporate governance portfolio. The pension fund, which is worth around $211 billion decided to invest in the hedge fund in March but the investment was made public only recently.

Richard C. Breeden launched his hedge fund firm earlier this year and the as of now, the strategy has $106 million. Company executives claim that the firm has already raised $500 million, However, it has only invested $100 million at present. With this latest hedge fund investment CalPERS has increased the percentage of hedge fund investment in its corporate governance portfolio. SPARX Asset Management, one of the fund's first hedge fund investments, still retains $679.5 million of the $3.6 billion program. Blackenterprise.com reports:

SPARX was hired in 2002 to employ corporate governance activism against underperforming, publicly traded Japanese companies. The firm recently was named one of the largest hedge fund firms in Japan in a recent industry survey.

Read more: CalPERS Adds Former SEC Chair's Hedge Fund

Fund of Funds or Single Fund?

If you are a high net worth individual, you’ve probably been through this dilemma: is it better to invest in a fund of hedge funds rather than a single hedge fund? One of the advantages of investing in a fund of funds rather than a single hedge fund is that you get more diversification. Financeasia.com reports:

Risk levels decline as diversification increases. It depends on investors as to whether they want a low risk product. Some fund of funds offer consistent absolute returns. They could offer better transparency and liquidity than some single funds.

Read more: Are hedge funds good for you?

Are hedge funds getting to be boring and predictable?

Common belief is that hedge funds are supposed to make money the risky way so why is it that hedge fund managers are now fighting shy of taking risks? Their argument is that their customers don’t want them to deal in such investments. So, for fear of losing these customers and more importantly, their fees, which can only be called exorbitant, hedge fund firms are now learning to play safe.

This sudden change in what is essentially a risk-taking business came about slowly. The sector's profile witnessed a change after institutions poured money in and drove worldwide hedge fund assets to more than $1,000bn. This large amount of money has weighed heavily on hedge fund performance and has led to ‘overcrowding’ in many strategies. As they reach critical mass, these firms begin to slowdown their aggressive activity and try to appease their major clients.

The changing face of the hedge fund market

In the past three years, the hedge fund industry has literally exploded in size and has gone from about $500 billion U.S. just back in 2003 to over a $1 trillion U.S. last year. The most interesting aspect about this spectacular growth is the increase in the number and types of investors who have begun putting their money into hedge funds. As a result, hedge funds, which have traditionally been short-term investors in public stocks, have undergone a sea change. They have now become players in the buyout, real estate and even venture capital market. All this growth is to sustain returns in an increasingly competitive space.

This trend has been accelerated by the introduction of new Securities and Exchange Commission rules requiring hedge fund managers to register for the first time. Managers that prohibit investors from redeeming capital within two years are exempt from the rule and a number of hedge funds are using the lock-up process to escape registration. As a result, many hedge funds have carved illiquid assets out of existing funds. This has in turn, tied up investors' money for a period of several years in the process.

Is there no difference between hedge funds & mutual funds?

As hedge funds grow and become too big for their boots, they need to diversify and grow. Geographic diversification is hence a natural progression. For a growing number of hedge funds this is the next step in their evolution from relatively simple vehicles into complex organizations. Iht.com reports:

There will be an industrywide scandal. This may seem a bit silly to say. Blowups and scandals have been a part of the hedge-fund saga since its first chapters after World War II. What is meant by this prediction is a broad industrywide scandal complete with multiple oustings of chief executive officers, congressional hearings, and studies by academics proving that the whole concept has gone wrong.

Read more: Funds: Hedge funds on road already taken

Caution is the new byword for hedge funds

Are hedge fund managers reluctant to make risky investments? Agreed hedge funds are supposed to make money the risky way but then they argue that their customers don’t want them to deal in such investments. So, for fear of losing these customers and more importantly, their fees, which can only be called exorbitant, hedge fund firms are now learning to play safe.

As fund managers realized that they were making a killing by raising money from pension funds, endowments, insurance companies and other institutional investors, their taste for the dangerous diminished. And the decisive factor was the 2 percent per annum management fees from large amounts of assets. With all these benefits, it didn’t take long for caution to become the new byword for hedge fund managers. However, any which way you look at it, hedge fund firms seem to be the gainers. Their strategy of caution allows their investors to repose more faith into these firms, which then translates to more business and more money.

Are hedge funds going the mutual fund route?

As hedge funds grow and become too big for their boots, they need to diversify and grow. Geographic diversification is hence a natural progression. For a growing number of hedge funds this is the next step in their evolution from relatively simple vehicles into complex organizations.

However, with diversification come problems associated with growth. Now as hedge funds begin to get money from traditionalists like pension funds, foundations, college endowments and the like, the pressure on them increases. They will now be forced to measure up against index benchmarks. And, very soon, we may even see them bidding goodbye to their ‘high costs’. So can we make predictions about the future of hedge funds since they seem to be following a well-beaten track – that of hedge funds? Iht.com reports:

There will be an industrywide scandal. This may seem a bit silly to say. Blowups and scandals have been a part of the hedge-fund saga since its first chapters after World War II. What is meant by this prediction is a broad industrywide scandal complete with multiple oustings of chief executive officers, congressional hearings, and studies by academics proving that the whole concept has gone wrong.

Read more: Funds: Hedge funds on road already taken

Banks wake up to hedge fund potential

Banks seem to have finally woken up to the immense potential offered by hedge funds. While the banks focused on catering to mutual funds and pension plans, hedge fund assets doubled in the past six years. Now, executives are trying catch up by offering record-keeping services to hedge funds. Iht.com reports:

But they are still missing the largest share of fees because strict lending policies keep them from providing what hedge fund managers want most: financing for trades.

Read more: Banks scramble to catch up on hedge fund fees

Hedge funds resemble mutual funds?

The total amount estimated to be managed by hedge funds stands at $1 trillion today; or about 7 percent of total U.S. financial net worth. And returns to large hedge funds, those with over $3 billion under management, are averaging between 10 and 15 percent annually. This is a far cry from the 40 and 50 percent that hedge fund managers used to get for their investors a few decades ago. Hedge funds began making money through their aggressive inclination to invest in more rapidly rising foreign stock and bond markets. However, as institutional investment in hedge funds increases, there is now a call for hedge funds to be less risk-taking and provide a more stable rate of return over a long period of time – something like a mutual fund.

Then what pray is the difference between the two types of funds now? Well despite the need to restrain more aggressive activity, hedge funds can still pursue a more unconstrained investment approach than most mutual funds. They can still employ leverage by going short, and pursuing multiple strategies. However, that does not deter from the fact that hedge funds ARE slowly beginning to resemble mutual funds. And the most obvious similarity is the structure.

Hedge funds are increasingly being structured more like mutual funds. Investment strategies that depend on long-only equity have allowed more institutions to expect a fixed rate of return on their investments annually. However, the downside of this effect is that despite hedge funds resembling mutual funds, their fee structure is still on the high side. Most hedge funds employ a two-and-twenty fee structure wherein the hedge fund manager gets 2% of the investments to operate the fund for the first year plus 20 percent of the upside of anything he earns. This fee structure often leaves small investors with returns no greater than, or sometimes less than, returns on mutual funds.

Are hedge funds trying to be risk-free investments?

Are hedge funds refusing to hedge bets on risky investments? It would seem so if GAM, the world’s biggest hedge fund firm is to be believed. According to GAM, it is hard to find managers who are prepared to take the levels of risk needed to produce the high returns wealthy investors demanded. News.ft.com reports:

David Solo, chief executive of GAM, which manages $55bn for private clients including $23bn in hedge funds, said the change in managers' risk appetite stemmed from their success in raising money from pension funds, endowments, insurance companies and other institutional investors

Read more: Hedge funds try to limit risk to avoid losing fees

‘Hedge funds are dangerous investments’

Hedge funds have suddenly become the rage all over. What was considered a risky adventure fit for those moneyed few has suddenly become one of the best methods of making money. And this has led to an explosive growth of this once reviled method of investment. Today the mounting integration of hedge funds into the world financial system has made most industry experts and even central bank policy-makers wary. They believe that hedge funds have increased the risks in the industry and need to be minutely scrutinized.

Sounds more like a doomsday warning. While on the one hand, the Nobel Foundation granted this industry a lot of credibility by investing some of its funds into the hedge fund market, there are others who believe that the growth of hedge funds could have serious implications. At a recent conference hosted by the Federal Reserve Bank of Atlanta on systemic risk, senior policy-makers believed that the unregulated activities of hedge funds could lead to serious problems. What is it that is worrying these financial gurus?

Most policy makers believe that these unregulated funds could, at some point in the future, cause a crisis, which could spill over into the real economy and damage its goals of low inflation and sustainable growth. According to them, the problem with hedge funds is that they use strategies, such as short selling and derivatives trading. This differs vastly from the strategies used by traditional equity and bond funds. To be honest, I don’t see a problem with being different.

Another problem according to experts is the increasing involvement of pension funds in this industry. According to statistics, the volume of investment made in hedge funds by pension funds has more than tripled. Pension funds have traditionally relied on much safer, and lower yielding, investments. All this noise about their lack of reliability has made the U.S. Treasury watch the hedge fund industry closely. And one of the outcomes of this close watch is that now, many hedge funds are required to register with the Securities and Exchange Commission.

Hedge funds on a roll, post strong first quarter

The continued boom in energy and hefty gains in the metal markets have helped hedge funds post a strong first quarter. The major hedge-fund indexes, which track aggregate returns for all strategies, showed gains ranging from 3.26 percent to 5.87 percent in the first quarter. Money.cnn.com reports:

The boom in corporate takeovers has propelled a select group of funds to bigger profits in early 2006 than they made all of last year.

Read more: Hedge funds post strong first quarter

Angelica directors face pressure from The Steel Partners Hedge Fund

The Steel Partners II LP hedge fund have been constantly pressurizing Angelica Corp in order to improve the company’s performance and therefore enhance investor value. The Steel Partners currently control about 20% of the company’s shares. As a major shareholder, the hedge fund has expressed its concern about the performance of the company time and time again.

Earlier the company had heeded to their advice and had formulated a special committee to take care of the concerns of Steel. However the hedge fund has expressed dissatisfaction with its activities. It is now asking the company to replace two of its existing directors. The hedge funds wants to replace the two directors with its own people. The directors who are being asked to step down are Stephen O'Hara, Angelica's chief executive, and Ronald Kruszewski, who is the head of the committee formed to address Steel's concerns. They are to be replaced by James Henderson and John Quicke, vice presidents of Steel Partners Ltd.

Angelica has even offered that that it will allow the inclusion of new directors in addition to its existing 8 directors. However the hedge fund has not accepted the offer and continues to ask for the removal of 2 directors so as to keep the number of directors limited to 8.

Since the company is not acting upon the request of the hedge fund, Steel has decided to send a proxy solicitation to Angelica's shareholders ahead of the company's annual meeting in May. This was made clear via a filing with the SEC recently.

Steel Partners II LP has observed that in the 3rd quarter of 2005, the company reported a loss of $381,000. However the company had made a net profit of $1.6 million in the same period a year ago. Representatives of Steel attribute this attrition in profits is clearly an outcome of Angelica's aggressive acquisition strategy in the last two years. STL Today reports:

“Steel, led by Warren Lichtenstein, is among a growing number of hedge funds that have taken an activist role in pushing for management changes.”

Will Convertible strategy work in 2006?

Last year a number of Hedge Fund managers were left with a bad taste after their convertible securities showed up with a very poor performance. Imprecise pricing led to significant losses and a lot of hedge funds were even driven to closing shop. Certain experts are however expecting the tide to turn the other way in 2006.

The stock market is expected to be much more volatile this year leading to a drop in interest rates and making the market conducive for a convetibles strategy. Convertibles strategy suit those investors who seek high income and are willing to be patient enough to wait for the conversion.

However if prices do not show variations, there is not much to gain from convertibles. But 2006 is expected to be different and will offer the necessary fluctuations for the convertible market to take advantage of. Unfortunately there aren't too many players in this segment as there were earlier. Market Watch reports:

Tom Ray from Inflective Asset Management in Manhattan believes the stock market will be much more volatile this year as interest rates rise and housing dips. That he says will be good for the convertible market as people seek to capitalize on the risk the market bears.

From the Classroom: What is Margin Trading?

Margin trading is defined as taking a loan from your broker for buying stocks. Margin trading involves high risk as not only do you carry the normal risks associated with trading but in case you lose, you also have to pay back the amount you borrowed to make the investment.

For trading in margin, a special account called margin account is required to be opened. Under the law, a margin account holder must fulfill two conditions. First, proceeds for stocks sold in a margin account are held by the broker against the repayment of the loan and second, the account must have a minimum balance called the maintenance margin.

If an investor fails to keep the maintenance margin in his account, then he is liable for a Margin Call. A Margin call means the investor is forced to deposit more funds in the margin trading account or sell his stocks in order to pay his loan. Margin trading can however yield great returns if the investor know how to leverage the money that he has borrowed. Fund Library reports:

You can draw some parallels between margin trading and the casino. Margin is a high risk strategy that can yield a huge profit if executed correctly. The dark side of margin is that you can lose your shirt and any other assets you're wearing.

Hedge fund manager sees potential in downtrodden stocks!

With the hedge funds market having more than 8000 players, it is but natural to see many managers opt for the same way. Several hedge funds seem to be emulating each other by using similar strategies and investing in similar companies. Those who swim against the tide sometimes do strike gold. They may also face disappointment however. But the real skill is in finding the unpolished or undervalued companies with potential. Manny Weintraub seems to be quite confident of his identification skills. He is the head of Integre Advisors, a New York-based long-only hedge fund. The fund was founded two Years back and invests about $140 million for high-net-worth and institutional clients.

Weintraub believes that the name of the game is ‘patience’. Those who are ready to wait till the cloud passes over the selected company can be rewarded with good profits. He has a well entrenched experience running funds for respected value-fund shops Neuberger Berman and the Davis funds. Weintraub fund charges 1% management fee and a 20% performance fee on profits that beat the benchmark. Integre's diversified hedge has so far performed well and has outperformed the S&P 500's 2.8% return by almost 9% points.

The fund has three favorable companies that they truly believe in. Cooper Companies Inc., which is a maker of contact lenses and competes with giants like Bausch & Lomb and Johnson & Johnson, is one of them. The other company which has sure shot potential is Platinum Underwriters Holdings Ltd, which is a former reinsurance division of giant St. Paul Travelers Companies. Another company that holds the funds interest is Reliant Energy. New York Daily news reports:

"I like the business because it's got a trend as big as a barn," he said. "You have people staring at computers and needing eye correction more than they used to."

Hedge Funds feed on tiny cash strapped companies

Financing tiny cash strapped companies is proving to be quite a bargain for some hedge funds. The market for this type of investment is currently worth more than $ 17 billion a year. Those who are playing in it are making are there with the intent of buying shares of these companies at a discounted price. These small companies who are looking at financers are sometimes referred to as Pipes – Private Investment in Public Equity.

One of the key players in the market is Laurus Family of Funds. In about 5 years their investment capital has increased from $5 million to $1 billion. The fund had been established in 2001 by Israeli émigré brothers David and Eugene Grin. Their funds have single mindedly focused on this strategy and has returned an average of 20% annually. The Street reports:

"The secret to Laurus' rapid success has been its single-minded strategy of investing in collateralized convertible bonds, a financing transaction Laurus pioneered and has peddled to scores of struggling micro-cap companies that trade on the OTC Bulletin Board and unregulated Pink Sheets.”

McDonalds fights shareholders wanting it to spin off it’s restaurant chain

McDonalds Corp is in the midst of a fierce battle between the management and the larger shareholders (read hedge funds). William Ackman who is a general partner of New York-based Pershing Square Capital Management LP is demanding the company to do some dramatic restructuring. As is the case with all the shareholder activism efforts, this one too is with the aim of improving share holder value. Ackman has asked the management to spin off its capital-intensive company-owned restaurant division known as McOpCo. A move that Management of McDonalds is definitely against.

This effort of Ackman is definitely being lauded by his peer hedge fund community. They feel that he is definitely on the right track. Shareholder activists like him are continuously on the move to look for underperforming companies that have a capacity to improve. More and more active and confident managers like him are engaging in confronting the managements of the companies in which they are investing. The core reason for this movement is because there is a lot of pressure on the hedge funds to generate high returns.

This is especially in the era when the stock market is showing a sideways movement. Investors are unable to make money in such a market condition. So the more demanding ones with deeper pockets are urging their hedge funds to generate more returns on their money. Consequently the fund managers are investing a whole lot of money in underperforming companies such as McDonalds and after they have a major clout, they voice their demand with authority.

Ackman is not alone in making this demand from McDonalds. Whitney Tilson, who runs T2 Partners LLC and is a McDonald's shareholder is also adding weight to the demand. Tilson adds that mutual fund industry is quite passive in their functioning. This is true with almost all areas pertaining to capital allocation, executive compensation, options etc. As such, though mutual funds do buy stake in the company, rarely does one hear even a whimper from them. On the other hand, hedge funds look for buried treasure and go all out to get them.

McDonalds is already in the process of spinning out its 461-store Chipotle Mexican Grill Inc. chain in 2006. What Ackman is demanding is that the stock of the company should be freed of operating about 8,000 stores. This way the remaining company can generate a large amount of cash that can then be used for share buybacks and to announce higher dividend. By doing this the company can collect franchise fees from spun-out stores and this would increase the value of the shares from $33 to over $45. Chicago Tribune reports:

“At Wendy's International Inc., for instance, Ackman and others successfully prodded management to spin off its Tim Hortons doughnut shops. McDonald's is doing something similar by spinning out its 461-store Chipotle Mexican Grill Inc. chain early next year.”

Hedge Funds, a force behind M&A deals!

Merger and Acquisition spells ‘big game’ these days. More of M&A activity is being witnessed than ever before more so in the European market. Take over deals that one could dream of less than half a decade back are now happening with a blink of an eyelid. Hedge funds do have a very important role to play in this development. This observation was made by Piero Novelli, who is the newly appointed global head of M&A at UBS. He also noted that the funds are quite cued on to the board room maneuvers of companies. Therefore what happens is that when a company decides on a restructuring plan or plans a takeover bid, the hedge funds swarm in and amass a much stake in the company as they can. Some times this figure has even seen to reach up to 60%. 

At this point, he mentioned the unsuccessful bid of Deutsche Boerse to takeover London Stock Exchange which ended quite tragically with the dethronement of its chief Warner Seifert. Now the move is on to push for merger of the German Boerse and pan-European exchange Euronext. This move is being initiated by stalwarts The Children's Investment Trust and Atticus.

Analysts have observed that the volume of mergers and acquisitions has crossed $916 billion in Europe up to now in 2005. This value is up by 56% from the value of last year. In US however this figure is close to 979.7 billion - A figure that is 34% up from the last year’s performance.   

In Europe, this growth is primarily due to developments such as the introduction of Euro and sale of large state assets. Homogenous accounting standards, move towards standard European takeover regulations and tax harmonization also have a big role to play in this game. Reuters reports:

“Under former investment banking chief John Costas, UBS successfully broke into the so-called bulge bracket of global investment banks alongside U.S. heavyweights such as Goldman Sachs, Morgan Stanley and JP Morgan.”

Hedge Funds want Versatel to change the constitution of its supervisory board

This time the hedge funds may not succeed in their ‘shareholder activism’ bid. Recently Swedish company Tele2 AB acquired 74% stake in capital of Dutch telecom firm Versatel. After this Tele2 replaced all four supervisory board members. They were replaced with its own representatives.

This move was however resisted by minority stake holders. These minority stake holders, chiefly hedge funds have a combined stake of 15.5%. There are three hedge funds involved - Amber Capital Investment Management, Centaurus Capital and Mellon HBV Alternative Strategies.

They are arguing that by replacing the supervisory board members the company is denying the basic rights of shareholders to be impartially represented on the board. They insist that the supervisory board is a kind of guarantor of the shareholder’s interests and rights. They are demanding that they be fairly represented on the board by the inclusion of at least two more members. These members however should not be related to Tele2 in any way.

The three funds feel that Tele2 will initiate a merger with Versatel via a new company and will therefore buy them out. By having a more independent supervisory board I position, they may have a chance of being fairly represented. The minority stake holders have been arguing that according to the Dutch law, the company taking over a firm has to cross a minimum threshold stake of 95%. This however has not been followed by Tele2. Despite this argument, the Amsterdam commerce court refused to grant a preliminary injunction. Reuters reports:

“The hedge funds and other minority shareholders opposed to the takeover have tried to stop the bid, arguing the procedure circumvented a 95-percent threshold required under Dutch law to squeeze out minority investors”

New seal of approval for hedge funds to provide some relief to investors

Hedge fund is an industry which is marred with unpredictability with frauds and collapses thrown in for extra flavor. This no doubt scares an investor who is aggressively hunting for a hedge fund that has strong fundamentals. Amber Partners now seem to have a solution for this dilemma. They have launched a new service which offers to certify hedge funds for operational risk.

What it really does is go through a hedge fund’s records, trading documents and corporate documents amongst other things. It then gives a firm analysis on the ‘riskiness’ of the fund. A comprehensive document is prepared post analysis which usually runs into 10-15 pages. The analysis is summed up in the form of executive summary.

This report is being predicted to be a good reference guide for investors who are looking at safer funds for investing especially in the backdrop of fund collapses like Bayou. This service might be especially useful at a time when a lot of pension funds, endowments and charities are spending billions of dollars into hedge funds.

Apart from this, key people at Amber feel that this document might be useful for the hedge fund managers as well. They feel that this kind of credibility report from a third party will help them to promote their funds to prospective investors in a better way. The first hedge fund to get this sign of approval is Vega Asset Management, which has lost many investors in the last few months and has seen its assets shrink amidst heavy losses in some of its funds. Amber has already certified 11 hedge funds up till now and hopes to at least double this number in a year’s time. A risk investment report from Amber partners costs a hedge fund anywhere between $40,000 and $500,000. The service may be extremely useful for a service such as hedge funds because of the notoriety of secrecy and usage of unconventional trading tactics attached to it. 

One thing needs to be noted though – the investors should know that the certification being provided is for operational risk assurance and not to give an assessment of a fund manager’s investment or trading risk. Therefore in the wake of recent collapses that have happened purely because of unwise bets rather than poor business practices, this report may not be very useful.

This view is shared by many in the industry including Bradley Ziff, head of the hedge fund advisory practice at consulting group Mercer Oliver Wyman. Despite this apprehension, people at Amber Partners claim that there is a beeline of hedge funds queuing up to have their hedge funds certified.

Amber Partners is a London and Bermuda based specialist. This venture is supported by several private as well as institutional equity investors like Bear Stearns, BNP Paribas, Anchor Asset Management and Alexandra Fund Management. Reuters reports:

“Industry analysts said Amber's services may prove popular in a business long considered secretive and risky even though managers can also deliver huge returns by using techniques that are off limits at traditional funds.”

New Blog Offers Accurate Survey of Hedge Fund Industry

While we here at Hedge Fund Street firmly believe that we offer the most comprehensive coverage of the hedge fund industry and its news, we are not afraid to point out some excellent alternatives. Largely regarded as one of the best, Hedge Fund Reader provides accurate frequently updated news and information on how to best manage the Hedge Fund Industry during this rather volatile time.

Man Group CEO asks regulators to stop blaming hedge funds

Stanley Fink, CEO of Man Group recently lashed back on those making allegations of hedge funds being unethical. Man Group is one of the biggest hedge funds in the world. Regulators have time and again commented on the hedge funds using inside knowledge of debt markets while making decisions on trading companies’ shares. It is actually illegal according to rules.

However Fink said that hedge funds are being unnecessarily blamed. He feels that the conflict of interest really begins at the level of investment banks. He stressed upon the point that these investment banks are traders in equity and debt markets. Apart from this they also have advisory businesses. Hence they are the ones who should be targeted.

FSA has raised concerns about the role hedge funds play in helping out Investment banks when called in to help test the market. These are situations where the banks need the help of outside parties including hedge funds in order to set pricings for shares and bonds issues.

The FSA feels that the hedge funds are therefore able to get all the information and thereafter are able to book huge profits by utilizing that information. Stanley Fink argues that it is a silly argument considering the fact that the investment banks are quasi hedge funds in themselves. On top of this they are also in an advisory role which complicates things further, so why blame hedge funds?

He further stressed that the hedge funds were quite ‘ethical’ in their dealings. If the FSA has to do something, it should make sure that the investment banks do not approach hedge funds to help them with the pricing activity. The Telegraph reports:

“Mr Fink said he believed that most hedge funds were "entirely honourable" and the only way to rid the market of abuse accusations would be to prevent investment banks calling clients like hedge funds before setting prices on bond or share issues.”

Investors swoon over Hedge Funds like Mutual Funds!

When the whole world is running after the hedge fund money, can the Mutual Funds investors be far behind? Some time back we had a write-up on the emergence of mutual funds that behave somewhat like hedge funds. Some mutual funds today employ strategies that are generally used by hedge funds. They are thus able to outshine their simpler counterparts in generating more returns for the investors. The profits may not be as high as that for hedge funds but are still noteworthy.

Investors find them a good alternative because the mutual fund managers charge less fees than the hedge fund managers. Apart from this there is better transparency as the rules and regulations for this investment tool are very rigid and strict. They are forever under the eyes of vigilant regulators hence the instances of fraud are limited. Then there is this issue of liquidity. Where as most of the hedge funds have mandatory lock in terms, most mutual fund units can be bought and sold when ever the investor wants. Mutual fund investors also enjoy higher level of oversight. 

The Wall Street Journal has observed that Mutual funds that are looking at achieving absolute returns like hedge funds are becoming more popular with the masses. They are attracting more and more investors every day with the promise of giving guaranteed returns. In the past two years itself their the number of hedge funds like mutual funds has increased several times. Vivienne Hsu manager of the Charles Schwab Hedged Equity Fund, predicts that the market will see more of such funds in the very near future.

There are others who do not share the same optimism though. They feel that due to stock markets flat performance this year, it might be tough for mutual funds to effectively employ hedge fund strategies. The fact that most mutual funds performance fell short of those of benchmarks such as S&P 500 also adds weight to their argument. Financial Planning reports:

“The 35 hedge-like mutual funds that Morningstar tracks manage a collective $12.7 billion, as of Sept. 30, while two years ago they managed $4.6 billion. More mutual funds are expected to head in the direction of hedge fund-like mutual funds, experts say.”    

Another reinsurance firm from Citadel hedge fund

Several hedge funds have been seen lately to be going the reinsurance way. Hedge funds like Ritchie Capital Management, Soros Fund Management and Moore Capital have already launched reinsurance firms. Citadel Investment Group also has a presence in the reinsurance market with its firm called CIG Re. Citadel has now added another reinsurance firm to the list with the launch of its second reinsurance firm called New Castle Reinsurance Co. Ltd. It is noteworthy that all these firms are based out of Bermuda.

The move towards reinsuring the insurance companies against the payouts expected during natural calamities is not very old. Hedge funds have moved into the sector in search of better returns. This move is specifically significant in a scenario where the returns from traditional stocks and bond strategies have been steadily declining.

Investing in reinsurance seemed to be a good option when seen in the light of how many natural calamities hit people in the modern day. People none the less like to insure themselves with the assurance of protecting themselves from some unknown disaster (however insignificant statistically) in the future. Therefore the premiums keep rolling in and the insurers and reinsurers keep making hay while the sun shines.

But then every once in a while major calamities like hurricane Katrina and Hurricane Rita strike resulting in heavy payouts. This can severely affect the pockets of these very firms. 2005 was one such watershed year. None the less, it did not prevent Citadel from venturing into the field yet again with another reinsurance firm.

The timing for the launch of the new firm is quite right with increased premiums under the shadow of the recent calamities. As such the new firm is up for good gains. However analysts feel that this might be short lived if the occurrences of 2005 repeat themselves the next year during the hurricane season. None the less the current situation is quite rosy and this is the way the firm wants to see it.

The new venture is backed by $500 million in fund assets. The parent, Chicago-based Citadel, has over $12 billion under management. Its earlier reinsurance firm CIG Re was formed in September, 2004 with $450 million in capital. The new firm has earned an ‘A-‘ rating from A.M. Best Co., the insurance rating agency. The high rating is given to the new company on the credentials of Citadel itself and its experienced management team. Reuters reports:

“But while CIG Re suffered what has been termed substantial losses from hurricanes Rita and Katrina this year, it did not stop Citadel from establishing the new company.”

The changing face of Hedge funds

Change is the core truth of mankind on which ‘evolution’ or even ‘survival’ thrives on. Hedge funds can be no different from this universal truth. The number of hedge funds has increased to over 8000 today. The net asset handled by the industry has long crossed $1 trillion. And returns from the industry are not as exotic as they used to be. Hence ‘crowding’ has occurred as a direct consequence of more number of people seeking better returns that are the hallmark of the industry. In order to survive, there fore it is not surprising that the industry is on a self innovating spree. Newer strategies are emerging and so are newer markets – all leading to a change in the entire landscape of hedge funds.

Over use of several well understood strategies has led to them not producing much by way of returns. Long/short strategies, Merger arbitrages, trading in convertible bonds etc fall in this class. Returns from these strategies have been slowly diminishing. Neil Brown, managing director of Citigroup Alternative Investments whose group structures new investment funds said that just old strategies fade away, newer ones emerge – this is the beauty of the dynamic field of hedge funds. He cites the example of credit default swap (CDS) market which did not exist sometime back. It is now a healthy $1 trillion market with hedge funds as a major contributor. 

Some new evolved versions of long/short equity funds have been observed as a direct consequence of raising demand of institutional investors. The profile of investors has also changed in the recent years. Previously only rich and wealth investors could invest in the high risk category. Now with some conservative and less risky versions being available, large institutional investors account for a sizable portion of the investors. And well while we are at it, by lowering of the seed money required to enter this ‘not so transparent’ investment area, the number of retail investors has itself increased. 

For example, Mellon HBV Alternative Strategies is buying Chinese non-performing loans today. This is a market that has seen phenomenal growth in recent years in Germany and in parts of Asia. And then there are some other funds that are developing long-short strategies in real estate, reinsurance, shipping and other less liquid asset classes today.

Though one cannot deny the relative illiquidity and riskiness of new investment strategies the pluses of possible creation of new markets is more important than it ever was. With hedge funds becoming more informed and hence picker hedge funds are doing what they have to do in order to survive.

Read more on this in a report by Reuters.

Now GPF wants to invest in hedge funds!

The lure of good returns is turning every one towards the thinly regulated field of hedge funds. Latest to jump on to the band wagon is the Thailand based Government Pension Fund. Its total asset base currently stands at Bt275-billion. Right now it is looking at allocating at least 3-5% of this in funds of hedge funds.

Funds of hedge funds are those funds that invest in basic hedge funds and not on portfolios. As such these funds are able to generate higher returns when compared to traditional investment tools. Risk though still comparatively high is spread and is not as high as it is for individual hedge funds. As of this moment, a comprehensive study is under way in order to assess the investment option.

Off late, GPF was finding it extremely difficult to generate decent returns in the volatile market. With returns from traditional investment tools like equities and bonds no where near satisfaction levels, more and more play safe institutions are turning towards the relatively risky investment option. Only smaller gains can be made in a scenario when the government is increasing interest rates and the stock and bond markets are correspondingly falling.

The GPF claims that it is eliminating much of the risk associated with the tool by firstly only investing in funds of hedge funds and that too limiting its exposure to a mere 3 to 5% of it’s investment portfolio. After it makes its decision, the next step would be to ask for permission from the Bank of Thailand and the Finance Ministry. GPF has for now made it clear that it will not implement its investment strategy immediately. Before anything else, it will expand its investment in property and overseas equity markets. One would recall, that earlier on, GPF has requested Finance Minister Thanong Bidaya to allow it to increase its exposure in equities from 20% to 25 % and in property from 5 % to 8 %. It had also requested that the ministry allow it to expand its overseas investment portfolio from 3 % to 5 % of its total assets.  Nationalmultimedia.com reports:

“The net rate of return to its members was 8.21 per cent in 2002 before rising to 11.84 per cent in 2003 and then sharply falling to 2.01 per cent last year.”

Hedge funds investment in India: The current scenario!

Asian market has been emerging as a lucrative market for many hedge funds. Though Hong Kong and Singapore top the list, a lot of activity has also been seen in the Indian market. With money making opportunities becoming rare in US and EU, hedge funds the world over have been seen aggressively pumping money in India.

To substantiate this take a look at the figures. According to some estimates 20-25% of the foreign funds flowing into the Indian market are from hedge funds. And up till now, in 2005, FIIs have invested close to $8.6bn in India. Out of this $2-3bn has come from Hedge funds alone.

However the investors now seem to have hit a stumbling block. One of the main contributors to the current situation is the rising interest rates in the US. Till now hedge funds were taking leveraged positions in emerging market equities by borrowing cheaply in the US. But with the interest rates in the US going up, the cost of leverage for hedge funds has gone up sharply. 

Another key reason is the depreciation of the local currency, Rupee. Dollar has appreciated in the last few months against most currencies and the Indian Rupee is no exception. A depreciation of around 3% has made the currency touch a low of Rs 45.18 recently. And this has hit the hedge funds adversely says Mr KR Bharat of Advent Advisory Service. He added that since the funds investing in India are leveraged funds they cannot stay put in the market and wait for the market correction mode to pass over. 

VVLN Shastry of Firstcall India, an advisor to foreign funds, commented that since the gap between the cost of funds and returns is narrowing, the hedge funds are now pulling out money from the Indian Market.  Economictimes.indiatimes.com reports:

“These funds also raise money through mortgages as rates were quite low a few months ago. The US mortgage rate, that was hovering at around 2% about six months ago, has now spiralled by over 400 basis points to a high of 6%”

How Man Group made it big in Hedge Funds Industry?

The story of Man Group is that of ‘Struggle to success’. What started off as a freak case of attempting to shield itself, today is a FTSE 100 company worth £5bn, managing assets of £25bn. Way back in early 1980’s Man group went by the name of ED&F Man. ED&F Man was essentially a trader in commodities such as cocoa, sugar and coffee.

The nature of the business itself is speculative and time and time again, ED&F Man used several financial instruments to minimize it’s losses. In short, it was attempting to hedge itself to protect itself against the fluctuations in the prices of these commodities. When it discovered the benefits of hedging it decided to make it more scientific and therefore more reliable. For this it joined hands with a statistician in 1984 who claimed to have developed a system of following trends in market prices. This was a turning point for the group and they have never looked back since. The next step towards sweet success came with the group acquiring a small investment management firm, Adam, Harding & Lueck. 

Adam, Harding & Lueck was employing a similar trend-following model and helped Man group to catapult to newer heights. This was the firm’s official entry into the world of hedge funds. Today, Man has come a long way from its original self thought techniques. So much so that the group today owns a fund-of-fund business investing in its own and third-party hedge funds. Man Group caught on to the Hedge fund tide at the right time and rode its way to success. But luck and good timing are not the only contributors to its success.

The firm also has a tough and practical functioning procedure which has built in several internal controls. Unlike most other hedge funds, they are not shy of opening up to regulators when required. Guardian.co.uk reports:

“Man has developed a long way from its original techniques. It now owns a fund-of-fund business which invests in both its own and third-party hedge funds. But the most rapid growth has been seen at Man Financial, the broking division named in the Pennsylvania court case.”   

Atlantic Investment wants Sonoco Buyback

Another company is struggling to fight back the onslaught of an activist hedge fund. This time it is a Dutch packaging company called Sonoco Products this is the victim. Alexander Roepers of Atlantic Investment Management has 5.6% of Sonoco's outstanding shares and is demanding that the company offer a Dutch tender or an accelerated share-repurchase plan. Atlantic Investment's strategy seems to be similar to that of Carl Icahn at Kerr-McGee and Mylan Labs.

The fund is looking at living with more leverage with Sonoco as against an acquisition drive. Sonoco seems to be doing fairly well and has a hold rating maintaining a leading position in its core markets for paper tube containers and composite cans. Key Banc analyst Christopher Manuel comments on the success possibilities of both the options suggested by the hedge fund. Thestreet.com reports:

"Shareholders have the right and opportunity to express their opinion," said Alan Cecil, a vice president of investor relations at the Hartsville, S.C.-based global packaging company.”

Read More: Hedge Fund Wants Sonoco Buyback

Hedge funds focus seen shifting from making profits to amassing assets

Today the focus seems to have shifted from generating returns to amassing assets as far as hedge funds are concerned. The truth is that this year’s ups and more importantly downs promise to show overall lesser returns from the industry. The industry which is so used to seeing double digit returns seems to be in for a rude shock by the year end. However the quantum of money flowing into the funds is ever increasing. The reason for this is clear. Managers want to make a quick buck. The more assets they attract, the more will be their asset management fee chunk.

Apart from the asset management fee, there is a 20% share of profit which will ensure that the bottom lines of the hedge funds are not affected. However little is being thought of about the investors who are investing in swarms in search of bigger profits. This observation was made by Mark Yusko, president and chief investment officer of Chapel Hill, North Carolina-based Morgan Creek Capital Management at a Reuters summit. Today.reuters.com reports:

“Industry experts have long noted that some of the sharpest financial minds are moving into hedge funds, the industry's hottest asset class. But some also say the industry attracts managers who have no other choices”

Read More: UPDATE 1-Reuters Summit-Hedge funds focus on assets, not returns

Lufthansa not to allow hedge funds to take over easily

Lufthansa, the German Airline is also facing a possible attack from the hedge funds. This seems to be in response to the market value of the airline being too low. Industry experts feel that in the current scenario of raising fuel costs, the current valuation of Lufthansa estimated at $6.28 billion is too low. This definitely is being seen as an opportunity by hedge funds that have been seen to be buying a lot of shares of the airline recently. Wolfgang Mayrhuber, the CEO of Lufthansa Airlines, however assured everyone that they will give a tough fight to the hedge funds.

He however declined to comment on the possible strategies at this stage. Never the less, he did mention that due to bilateral air connections agreements it would be very difficult for hedge funds to attack the company. Even Commerzbank has shown concerns over a possible onslaught of the hedge funds on the bank in the wake of them controlling anywhere between 10 to 15 percent of the bank’s stock. Hedgeco.net reports:

“According to Mayrhuber, a growing number of hedge fund managers have acquired large shares of the airline, and such shares were purchased during market dips.”
   

Read More: Lufthansa CEO says company will avert any hedge fund attack

Rydex Mutual Funds Mimic Hedge Funds

Rydex Investments introduced two unique mutual funds today. The new funds will somewhat mimic hedge fund strategies thus making the returns resemble that of hedge funds as well. Rydex is attempting to offer investors a way to still make money through their mutual funds using hedge fund strategies despite that fact that the market may be down. The Rydex Hedged Equity Fund will be instituting strategies known as "market neutral" which will be utilized by hedge funds, investment pools geared towards wealthy investors, and institutions. According to Reuters:

With traditional fund products investors had "limited tools to mitigate down markets" and "didn't have anything to address it head on," David Reilly, director of portfolio strategy for Rydex, said at a briefing in New York.

Read more: Rydex launches two "hedge fund-like" mutual funds