September 2007
« August 2007 | Main | November 2007 »
September 24, 2007
Why hedge funds are still a safe bet
Hedge fund assets could hit $2 trillion this year, a staggering number that has many investment pros saying there’s too much money chasing too few opportunities and, thus, these private partnerships have seen their best days. Ed Easterling, 47, founder and president of Crestmont Research in Dallas, takes issue with the critics.
After working 20 years in private equity, Easterling established his firm in 2000 to select hedge funds for high-net-worth investors. He also teaches a course on hedge funds at Southern Methodist University's Cox School of Business. An interview:
Is it right to say hedge funds failed in 2006 because they trailed the S&P 500 on average?
No. The idea behind a hedge fund is to control downside risk. If you’ve done that, you don’t need nearly as much of the upside to just match market returns over time. Let’s say you could break even in months when stocks go down. What share of the upside during up months would you need to match market returns over time? Most people think it’s close to two-thirds but it’s just 30%. Last year some people said hedge funds didn’t work because they got a 12% return in a 15% market environment. That works if you can also avoid the downside.
Do hedge fund indexes overstate average returns because bad funds can drop out whenever they want to?
Hedge funds list their returns in those databases voluntarily, so investors can see them. The databases act like a dating service. We’ve found that some of the best funds don’t report because they’re closed to new investors. Some leave the databases if they’re performing well because they no longer need the exposure. Studies have shown that twice as many funds withdraw from index databases for good performance than drop out for bad.
Many people also see the fees on hedge funds and complain that they’re too high. Are they?
People grew very fee-conscious in the ‘90s, and it’s probably causing them to adopt hedge funds slowly. As with professional fields, there is often a strong relationship between the level of performance and level of compensation. If manager skill is the source of the return, well, you get what you pay for.
Keep in mind that in general, the majority of hedge fund fees are profit sharing, which makes the fees self-adjusting. If performance declines, so will the fees. And the fees are in line with other sorts of alternative investments . If we look at private equity, venture capital, real estate, timber, and so forth, the overall level of fees is consistent.
Don’t hedge funds use a lot of borrowed money, which creates more risk?
Most hedge funds employ modest or no leverage, and relatively few use leverage to boost returns from general market exposure. Actually, most funds use leverage—under a loose definition of the term —to add hedges to the portfolio in order to reduce risk.
Are you concerned that the hedge fund industry has become too big?
Well, presumably the concern would be lower returns. If you look, despite record capital and a record numbers of hedge funds, they had great returns in 2006. It has continued into this year. In aggregate, even if there is $2 trillion in these funds, the markets within which they participate are more than $100 trillion. So hedge funds still represent less than 2% of global financial assets. The dollars sound big, but the key is that the fields they operate in are even bigger.
Didn’t convertible arbitrage funds suffer a few years ago from too much money?
That’s a great example of what happens when too much money goes into one niche. People didn’t lose a lot of money, but the returns diminished significantly. Then money came out, and it has been a terrific strategy over the past year or so. Hedge funds, because of the way they operate , can lead to overinvestment in certain markets. Yet, as we saw with converts, the markets will ultimately correct. Even then, it didn’t cause a major blowup.
Financial markets are not always efficient and perfectly priced, and the actions of hedge funds will help iron out the inefficiencies and get them back in line. Over time, we’ll see continued proliferation of new investment styles. Any time a new market gets active, whether its energy futures or weather derivatives, hedge funds come in. That enables the industry to expand without the kind of concentration that crimps returns.
Do you agree when people say hedge funds are lightly regulated?
No. It’s another myth. Hedge funds are required to comply with every rule, regulation , and law that affects virtually all investors in the financial markets. Then there are a variety of investor-related laws and regulations that impact who can invest with hedge funds. There are state and federal laws that require some managers to register as investment advisers—which adds additional regulations and requirements, including periodic examinations and filings.
Why are there so many myths, in your view, around hedge funds?
Laws and regulations preclude hedge funds from discussing their activities publicly , so they appear exclusive and elusive, though not necessarily by choice. When the underinformed view an unfamiliar process that operates with different principles and objectives, the natural result is myth and misunderstanding.
-The Economic Times-
Posted by su at 4:27 PM
Asset flows moving from long-only equities to hedge-like strategies, says Tabb study
By contrast, actively-managed US equity mutual funds, the largest segment of the mutual fund industry in terms of assets under management, will grow by just 3 per cent over the same period, the group predicts in the study, entitled Alternative Investments 2007: The Quest for Alpha.
The survey also finds that 40 per cent of fund managers believe trading costs are the most significant cause of lost alpha, while only 35 per cent of managers believe brokers help them capture alpha. However, size and satisfaction are linked as larger management firms are overwhelmingly more satisfied by their brokers' ability to help them capture alpha.
'A major change is underway at alpha-seeking firms,' says Larry Tabb, founder and chief executive of the eponymous firm and co-author of the study with Jerome Johnson. 'They are becoming more creative, moving overseas and towards frontier markets, moving up and down the capital structure, moving toward shorter-term, event-driven strategies and longer-term holding strategies that resemble private equity-type investments.
'Also, shorting and leverage, used by the first hedge fund as early as 1949, are becoming more sophisticated and mainstream, proven by the explosion in assets under management in enhanced active, enhanced long and short extension equity strategies.'
Ninety per cent of the fund managers interviewed believe that the growth of active-extension funds will increase as the pressure for increased yield and increased fees push traditional managers into this new area.
However, this shift in asset flows cannot happen by itself. Says Tabb: 'It must be driven by the clients of today's asset-management companies, from pension plans, trusts and foundations to corporations and high net worth individuals. It also includes massive mutual funds that cater to the mass-market retail investor. As these firms reposition themselves, expanding and transforming to cater to their clients, other changes must happen as well.'
The report says new products and strategies such as absolute return, portable alpha, and multi-alpha funds will affect the investment value chain. As managers seek to become more global, they must expand asset selection strategies and become more nimble about moving in, out and between different risk and capital structures. This will affect how firms are serviced and brokered, technology infrastructure is implemented and operations are structured, all in pursuit of alpha.
'This will also affect investors, because track records do not yet exist and these complex strategies have few services to vet them or ensure their fidelity,' Tabb says. 'But with opportunities come adventures and as long as the oyster doesn't close on a finger, the quest to find the pearl can be exhilarating, the rewards enormous.'
Tabb Group interviewed 67 portfolio managers, chief investment officers, heads of research and senior managers of hedge funds, funds of funds and traditional long-only asset managers, with a particular focus on traditional equity managers who have launched active-extension funds.
Collectively the respondents manage USD12.3trn in assets, with more than 90 per cent of those assets managed by large fund companies (defined as managing assets of more than USD50bn for traditional managers and USD2bn for hedge funds).
Other findings from the report include the belief by almost half of the fund managers surveyed that new geographic markets will generate their greatest source of new alpha.
The study predicts that research with continues its transition from a sell-side function to one performed by the buy side. By 2012, the buy side will generate 63 per cent of its research internally, the study says, with spending on broker research declining to USD3.42bn.
More than half of the fund managers surveyed say they will increase their spending with independent research providers, whose revenues are expected to grow from USD1bn in 2002 to USD2.4bn in 2012, a compound annual growth rate of 9.15 per cent.
Tabb Group is a research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on an interview-based research methodology developed by Larry Tabb, the firm analyses and quantifies the investing value chain from the fiduciary, investment manager, broker, exchange and custodian.
-hedgeweek.com-
Posted by su at 4:21 PM
September 13, 2007
Emerging Funds Tumble
Emerging markets hedge funds were the weakest link in the industry last month, according to Hedge Fund Research, with those focused on Russia and Eastern Europe tumbling 3.89% and Latin-focused funds falling 2.93%. The performance was a dramatic turnaround for emerging markets, which enjoyed a strong July and strong year-to-date figures. Overall, HFR says hedge funds posted losses of 1.31% for the month, according to reporting by 40% of the 2,000 funds it tracks. Another previously solid performer, macro strategies struggled, posting -2.18% for the month, as a result of sharp reversals in key markets, as well as in economic indicators, says HFR. Other big losers in August, according to HFR, were fixed income strategies, with fixed income: diversified declining 1.55% and fixed income: high yield finishing -1.97%. The bad news is that HFR predicts the industry will feel the effects of market turbulence for the foreseeable future. "Hedge fund performance volatility increased at the end of July and has persisted into September, driven in part by investor concern about continued deterioration in the subprime mortgage sector and the
corresponding impact on access to liquidity by other consumers and corporations," said HFR President Kenneth Heinze. "While a number of strategies posted losses for the month, much of these aggregate, intra-month losers pared into month end." On the bright side, the fund tracker notes that after 10 consecutive losing months, short selling came up a winner for the third month in a row, adding 1.29% in August for a three-month gain of roughly 11%. Also, quantitative funds recovered more than 65% of their intra-month losses by the end of the August. Meanwhile, some market watchers are saying August will turn out to be not as bad as originally expected, with the industry experiencing its first down month of the year, but only in the 1 percentage point range, one-third of earlier predictions. Analysts warn, however, that the worst performers tend to wait until the last minute to report, so there can still be some nasty surprises in store.
-Institutional Investor-
Posted by su at 2:18 PM | Comments (0)
Quant fund returns
Computer-driven hedge funds, or “quants”, posted mixed results in August, providing investors with a mixture of hope and despair.
Some funds recovered fully, while others are stuck with most of the losses from the appalling first 10 days of the month. One of New York-based Tykhe Capital’s funds and two hedge funds from Goldman Sachs are down more than 20% for August, investors said, while funds from GMN Capital and Algert Coldiron Investors are down close to 20% for the month.
Some of the other ‘quant’ funds bounced back strongly in August, including big names such as Renaissance Technologies; 32 Capital from Barclays Global Investors; DE Shaw, part-owned by Lehman Brothers; and Highbridge Capital, owned by JPMorgan.
A handful of other quant funds, including Sushil Wadhwani’s Wadhwani Asset Management, which uses both macro and equity strategies, avoided the crisis altogether. Wadhwani ended the month down just 0.5%, hurt by the move in the yen.
-Financial Times-
Posted by su at 11:52 AM | Comments (0)
Hedge Funds down 1.8% in Aug 07
Aug 2007 Hedge Fund Indices
Early reporting funds to the Eurekahedge databases suggest a flat to negative month for hedge funds across the board, this August, owing to credit fears and high market volatility. Arbitrage players, though, benefiting from the volatility, turned in returns of 0.3%, for the month. Equity markets, after falling sharply during the first half of the month, made a healthy recovery during the latter half, however, long / short equity managers, largely owing to the trendless pattern (and the extent) of volatility, were down 2.1% for the month. Hedge funds in Greater China, returned a healthy 1.1% (largely benefiting from rallying equities), while the emerging markets on the whole, were down 2.2%. North American managers, who were among the least negative for the month, were down 1.2%, making gains from Arbitrage (0.5%) and Relative Value (1.4%) plays.
-Eurekahedge-
Posted by su at 11:32 AM | Comments (0)
September 10, 2007
Subprime crisis tests hedge funds
You could say that this summer's credit crunch was a chance to see the hedge fund emperors without their clothes.
As banks around the world tightened access to money, on concern that borrowers' collateral was impaired by exposure to subprime loans, some of the highest-profile upsets were reported in the $1.7 trillion hedge fund industry. As these secretive and unregulated funds scrambled to raise cash and dump tradable assets, tales of double-digit losses, implosions and bankruptcies replaced Paris Hilton in the headlines.
The crunch, which is still working its way out of the world's financial system, raised big questions about the viability of some hedge fund strategies in the absence of easy money, which had encouraged fund managers to take on increasing levels of leverage and risk.
Whether there will be a major shakeout is still an open question. For August, the Hedge Fund Research index, which uses 75 component funds weighted to represent 7,600 single-management hedge fund strategies, was down 2.5 percent after sinking as much as 4.5 percent at midmonth.
Ken Heinz, president of Hedge Fund Research in Chicago, noted a "greater dispersion between strategies and between funds." It is a time, he said, when funds "have the opportunity to distinguish themselves" from the pack.
It is also an opportunity for investors to get some insight into an industry whose activities are often cloaked in secrecy and which has
wandered far from its original purpose of hedging volatility.
Before hedge funds were opened to the merely affluent, they were the near-exclusive purview of the very well off - those with at least $1 million to invest and $1 million net worth. So one place to look for clues to evaluate hedge fund strategies is private bankers, who have advised wealthy clients for decades on hedge fund selection as part of an overall investment strategy.
While private bankers tend not to divulge for free the specific advice they give their high-paying clients, they generally agree that one of the major tenets for hedge fund selection is that quality is not defined solely by performance. What they look for first is a clear sense of strategy and purpose, as well as a level-headed approach to risk.
"When we invest in a hedge fund, the first and most important point for us is the people. Then we ask, 'What is your strategy?' " said Christof Reichmuth, chief executive of Reichmuth Private Bankers in Lucerne, Switzerland. "Then we want to know, 'In what environment does your strategy work, and when does it have a headwind?' "
Performance, he said, comes into the picture afterward. Reichmuth's two funds of hedge funds, Reichmuth Matterhorn and Reichmuth Himalaja, were the two best-performing funds of funds in Switzerland in the year ending June 30, according to Neuer Zürcher Zeitung, a top Swiss daily.
While some investors associate hedge funds with risk-taking gurus like George Soros, the goal of the father of the hedge fund, Arthur Winslow Jones, back in the 1950s, was very different: to avoid market risk and still produce outstanding results by hedging his long positions with significant short positions, typically using modest leverage.
"Most private clients feel hedge funds are a way to risk more money," said Daniel Pinto, co-founder and managing director of Stanhope Capital, a London-based firm that manages the affairs of European families with very large fortunes. "They do not understand that hedge funds are supposed to be a protection for your portfolio. They are a buffer against volatility. They are not supposed to perform at 30 and 40 percent."
Alfred Roelli, head of research at Pictet, a private bank in Geneva, remembers when Soros and Michael Steinhardt, founder of Steinhardt Partners and one of the most successful of the early hedge fund managers, employed a mix of shrewd intuition and risk control. Steinhardt's fund returned 24 percent annually compounded over 28 years.
"They took risks," Roelli said, "but they were calculated risks that worked in 99 percent of cases."
Today's bandwagon investment managers, Roelli said, are far more reckless. "From 200 hedge funds to between 6,000 and 10,000?" he asked. "There are simply not that many people qualified to run a hedge fund."
Mention the computerized quantitative or black-box methodology that hedge fund math whizzes embrace, and private bankers grow queasy.
"We won't touch them," Pinto said. "The programs are quite sophisticated. They do work in stable markets, but they have a fundamental weakness. There is no room for judgment. When markets behave erratically - as they have recently - the inability to use common sense to make investment decisions, combined with a high level of leverage, is a recipe for disaster."
The collapse of Long-Term Capital Management in 1998 proves his point. The recent problems of some of the best known multibillion-dollar "quant" funds are a stark reminder.
"We have had pressure from some clients" to buy quant funds for their accounts, Pinto said. "We say, 'If you want to buy it, you won't do it through us.' "
When the pressure for higher returns is met by an equally human desire to believe what one wants to believe, the result can be disastrous.
Take the penchant for CDOs, or collateralized debt obligations. These are securities comprising a bundle of assets that may include loans, mortgages and bonds with different levels of risk and a variety of yields. They are then divided into segments with different default characteristics.
As it became more difficult to make money in bonds, many hedge fund managers turned to these more complicated debt instruments. But many CDOs are stuffed with subprime mortgages that are now beginning to default at a far higher rate than originally predicted. It is the inability to assess the value of CDO portfolios that caused the current liquidity crisis and the bankruptcy of several hedge funds.
William Pool, president of the Federal Reserve Bank of St. Louis, Missouri, speaking in July after several hedge fund disasters, commented: "It is surprising to me that sophisticated capital market investors willingly purchased securities backed by such poorly underwritten mortgages."
As the credit market swung from greed to fear this summer, some hedge fund investors began asking questions. Pinto said Stanhope's clients reflected concern about two themes. First it was, "Tell me about my CDO exposure. What do I have?' "
The other theme was liquidity. Investors worried about whether they would be prevented from redeeming their investment. Pinto pointed out that hedge fund gates - limits to the total amount of assets that can be redeemed - could prevent forced selling at fire-sale prices.
However, he said, the really unexpected event came from so-called dynamic money market funds, which offer enhanced return over money market rates by investing a small portion in riskier credit instruments.
In France, several funds that held CDOs temporarily closed, confessing their inability to value certain securities as the credit market froze. "We were not touched," Pinto said. "But it made us extremely careful about the dynamic money market products we are using."
Stanhope is now recommending that investors buy equities, especially in Europe, where Pinto finds the market, at 13 times earnings, undervalued. Even the United States, which trades at 15 times earnings, is attractive, he said.
"The world economy is healthy, so we don't expect a sudden collapse" in earnings, he said. "And the fact that interest rates are going up is not going to affect the larger corporations. They have a lot of cash."
Pictet has also raised its recommended allocation to equities. "The bond market has become more and more nontransparent," Roelli said. "Relative to equities, bonds are riskier."
Reichmuth is one hedge fund manager that profited from the turmoil. Anticipating the subprime problem as long as a year ago, as spreads between top-quality and low-quality debt issuers converged, he found three hedge funds that shorted the subprime market, one of which hit a home run and helped his funds produce a 4 percent gain in July. In another tactic to hedge long equities, Reichmuth shorted an index of broker-dealers, whose stocks tended to fall faster than the market over all. Reichmuth is also currently positive on Asia and on the yen.
But while short-term moves to catch trends are what smart hedge fund managers do best, individual investors probably do better with a long-term view. The current market turmoil is "having a massive effect on every asset class," Pinto said, "but people shouldn't throw in the towel and say everything is risky. People should keep cool heads and see where there are values."
-International Herald Tribune-
Posted by su at 12:06 PM | Comments (0)
Dirty little secrets of hedge funds
One reason hedge funds are so popular is their ability to protect against market downturns, usually through short-selling or options-related strategies. This gives them a distinct advantage over most mutual funds, which are limited to "long-only" investment strategies that place them at the mercy of wild market swings.
But for most of the past decade, hedge funds have become less about "hedging" and more about leveraging assets to produce outsized returns. This addiction to leverage, combined with questionable accounting techniques, is now coming home to roost for many hedge funds.
Over the past few months, hedge fund blowups have become commonplace. From behemoths like Sowood Capital Management (which lost $1.5 billion in investor assets) and Bear Stearns (which lost a similar amount), to smaller niche players managing "only" millions instead of billions, it is a rare day when at least one previously successful fund doesn't close its doors for good.
How can this happen, you might ask? After all, aren't hedge funds managed by the best and brightest investing minds in the world?
Well, there are two dirty little secrets in the hedge fund world that most investors never see, and they are called "leverage" and "mark-to-market accounting." And while they might sound innocuous enough, when combined they are as dangerous as fire and gasoline.
Leverage is simply a fancy word for borrowing. While almost all of us borrow money, few do so as prodigiously as hedge funds. Many of these funds leverage their asset base through margin loans by five, 10, or even 20 times its actual value - allowing a $100 million hedge fund to control more than a billion dollars in investments.
When done correctly, this leverage allows them to potentially earn huge returns for their clients. It also puts them right in the cross hairs of a market decline that could decimate their portfolio. For example, a portfolio that is leveraged 20:1 need only experience a 5 percent loss to wipe out the entire asset base, forcing the fund to close and leaving the fund's investors with nothing.
"Mark-to-market," on the other hand, is an accounting concept that simply means that at the end of every day, an investment is "marked" to its current fair value.
Seems simple enough, doesn't it? Unless you are a hedge fund. Many hedge funds, particularly those dabbling in illiquid assets (such as sub-prime mortgage debt), simply hold their assets on the books at cost.
While this approach works in a strong market environment, problems arise when, like now, the underlying market for these assets collapses. At some point these hedge funds have to come clean with their investors and report their assets at fair value, which in many cases will be only a fraction of their original cost. When that happens, their investors will be in for quite a shock.
Now combine that leverage with the concept of "mark-to-market" accounting and things get ugly.
Assume when "Hedge Fund A" reports its real net asset value, it receives redemption calls from some of its unhappy investors or is asked to provide additional capital as collateral for its margin loan - something that is happening all over the world today. It has to sell some of its illiquid assets to raise cash. But as you may have guessed, there are no ready buyers for these assets, so the fund has to either sell other things in its portfolio (such as publicly traded stocks) or take pennies on the dollar for its -illiquid assets (assuming it can find a buyer at all).
Not surprisingly, this story ends poorly for everyone. As the fund's asset base dwindles, more investors scramble to redeem their shares, more liquidations are necessary, and the market continues to soften. Eventually the fund is forced to close its doors, write a mea culpa letter to its remaining shareholders and shut down for good.
We have seen this happen repeatedly over the past few months. Unfortunately, this may only be the first inning of a very sad and expensive game in which billions of dollars in investment capital will be wiped out. While this is ultimately healthy for the markets as a whole, it will be a tragedy for some hedge fund investors caught in the middle.
-rockymountainnews.com-
Posted by su at 11:51 AM | Comments (0)
Paulson Credit Fund rises fivefold on subprime bets
Paulson & Co.'s biggest credit hedge fund rose fivefold in 2007 after the New York-based investment firm with $20 billion in assets under management bet U.S. subprime-mortgage defaults would soar.
The $4.5 billion Credit Opportunities fund, started last year, gained 26.7 percent in August, according to a Paulson investor. Credit Opportunities II, a newer $2.3 billion fund, is up more than threefold after a 32 percent return last month. The firm, founded by John Paulson in 1994, more than doubled its assets since the start of the year.
U.S. home-loan foreclosures rose to a record 0.65 percent in the second quarter, according to the Mortgage Bankers Association in Washington. U.S. asset-backed debt including some mortgage-backed bonds fell 3.5 percent last month following a 1.2 percent drop in July, the two largest declines in at least 13 years, according to Merrill Lynch & Co.'s broadest index that includes bonds linked to subprime or second mortgages.
``These guys made a big bet at the right time, and they're being rewarded for it,'' said David Nelson, chief executive officer of Greenwich, Connecticut-based DC Nelson Asset Management LLC, which isn't invested in the Paulson funds.
Hedge funds run by Goldman Sachs Group Inc., Tudor Investment Corp and D.E. Shaw & Co. declined amid widening credit spreads and stock-market volatility. Losses in subprime- related holdings forced managers including New York-based Bear Stearns Cos. to close funds.
SAC Capital
SAC Capital Advisors LLC, the Stamford, Connecticut-based hedge-fund firm run by Steven Cohen, raised $1 billion from investors last month as its biggest fund fell 3 percent. The $8 billion SAC Capital International Fund finished August up 10 percent for the year, according to an investor who declined to be identified.
In August, Paulson increased 5.2 percent in its event- driven fund that invests in debt of distressed companies, extending that fund's 2007 advance to 69 percent.
A spokesman for John Paulson declined to comment.
Before starting his hedge-fund firm, Paulson, 51, was general partner at New York-based investment firm Gruss Partners. He was a managing director at Bear Stearns from 1984 to 1988 after earning a master's degree from Harvard Business School in Boston.
Managers had their second-best fund-raising quarter from April to June, attracting $58.7 billion globally from investors, according to industry tracker Hedge Fund Research Inc. of Chicago. Hedge funds oversee more than $1.7 trillion, almost triple the amount five years ago.
-Bloomberg.com-
Posted by su at 11:42 AM | Comments (0)