FINANCE
HEDGE FUNDS
HEDGING YOUR BETS In the recent market turmoil, hedge funds have outperformed equities
funds invest in the new economies of eastern Europe, central Asia and areas where growth is volatile and market conditions are less than perfect; and Special Situations funds look for incidents such as mergers, hostile takeovers or leveraged buyouts to profit from. The advantage for investors is that the various strategies are – or are meant to be – noncorrelated, meaning that if one strategy crashes, the others won’t necessarily be affected. The big question now, of course, is how are hedge funds doing? Given market conditions over the past year, and particularly in September, they should, by all accounts, be delivering above-average, non-correlated returns to happy investors. After all, that’s their selling point: the ability to deliver an absolute return when markets are tanking as well as when they are up. The answer is decidedly mixed. According to Chicago-based Hedge Fund Research, the average fund lost 4.83% in the first eight months of the year (to the end of August) – their worst returns in a decade. Previously the worst year was 1998, when funds were down by 5.5%, the giant fund Long Term Capital Management collapsed, and the world’s financial system almost went down with it. On the other hand, hedge funds have outperformed long-only funds – US mutuals tumbled by 13.28% through 4 September. But that ‘outperformance’ was still much worse than simply hoarding cash. “I think we’re seeing what these hedge fund managers really, truly are,” says one as-
set manager. “And some of them really can’t make money in a difficult environment.” The proof will be in the coming months, when strategies will have either been proven or disproven by the markets. Hedge funds are meant to deliver over the medium term – a year, say – not each and every month. Though shorting has recently had a bad press – being blamed, somewhat absurdly, for causing the collapse of tapped-out finan-
THEIR SELLING POINT IS THE ABILITY TO DELIVER WHETHER MARKETS ARE UP OR DOWN cial institutions – it’s notable that the suspension of shorting, in both the US and the UK, is temporary. This should be a relief to investors: shorting is a perfectly legitimate way of making money in a declining market. The other strategy that has produced above-average returns this year is macro – appropriately, perhaps, because it tends to benefit from turmoil. According to data from Credit Suisse Tremont, macro funds returned on average 18.8% in the year ended in June. Macro funds have enjoyed some major themes to boost their returns, among them seven Federal Reserve interest rate cuts since September 2007, the surge (and subsequent decline) of oil and other commodity prices,
the plunge by financial stocks and the weakness of the dollar. For macro funds it doesn’t matter whether the economy and markets are weak or strong, as long as there’s a trend. Hedge funds have been called many things. One well-known hedge fund manager said they were “highly speculative vehicles for unwitting financial fat cats and careless financial institutions to lose their shirts.” Some regulators have said they posed “systemic risks”. This view has been reinforced by the periodic, well-publicised blow-ups of large hedge funds, from Long Term Capital in 1998, through the meltdown of the Tiger Funds in 2000, to the collapse of Amaranth and Peloton within the last three years. To the general public, there always seems to be a hedge fund disaster about to happen. But what’s been notable in 2008 is the dog that didn’t bark – at least not yet. The collapse was instead among highly regulated investment banks, mortgage companies and insurance conglomerates. One reason for this, perhaps, is that these institutions played with other’s money, receiving huge bonuses if they succeeded and little sanction if they failed. In hedge funds, things are different. Most often hedge fund managers invest their own money in the fund and take key decisions themselves, or at least closely watch those who do. Their incentives to take huge risks have been smaller. So these have at least survived. In markets where ‘flat is the new up’, as the current City witticism has it, surviving is the ultimate defensive position.
30 CNBC EUROPEAN BUSINESS I NOVEMBER 2008
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