January 2008
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January 31, 2008
Why hedge funds look so smart
Observers used to say hedge funds would cause financial disaster, but it appears in retrospect that they proved to be better at managing risk than banks.
According to Financial Times, Morgan Stanley lost more money in write downs and bad trades than Long Term Capital Management and Amaranth Advisors, the two highest profile HF disasters, combined.
“If you are handing out report cards for 2007,” John Coyle of JPMorgan told FT, “the hedge funds are looking like some of the smartest kids in the class at the moment.”
HF managers point out this difference between hedge funds and banks, says FT: Banks and brokerage firms take risks with other people’s money; “incentives are skewed toward uncontrolled risk-taking on the theory that heads, the traders win, and tails the shareholder lose, but the bonuses when they bet successfully are all theirs.”
Hedge funds look at things differently.
“Because it is our capital, we move more quickly to reduce risk,” an unnamed HF manager told FT. The paper cites as an example the moves by Jeff Larson of Sowood Capital Management, who closed the fund after it lost 55% of its investor money from wrong way debt bets.
“If it had been a Wall Street firm, everyone would have gotten zero back.”
FT further notes that many hedge funds have strict loss limits, even writing in their offer documents. Banks don’t - and some, like Morgan Stanley, and their customers, may have paid for it dearly.
Posted by su at 11:54 AM
January 24, 2008
Strong demand for quality funds
Headlines about the ongoing crisis in financial markets have been difficult to ignore and problems at specific hedge funds have formed part of the unfolding story. Indeed, large losses at two Bear Stearns mortgage credit funds were one of the catalysts for market volatility in July and August. It would be wrong, however, to conclude that 2007 has been a disastrous year for hedge funds.
For a start, the hedge fund industry now comprises more than 7,500 funds and 2,400 funds of funds, but it is still the small number of failures that grab most media attention. 'The problems suffered in the summer by some credit funds were well-publicised. Less well-documented is that a handful of funds were short sub-prime mortgages and were part of a group of funds that at the end of October were up more than 100 per cent for the year,' says Ken Heinz, president of Hedge Fund Research (HFR), the alternative investment database and index provider.
The most recent performance data from HFR paints a relatively upbeat picture. The hedge fund industry attracted a record USD194.5bn in new investor capital in 2007, bringing total assets under management to USD1.87trn.
Inflows for 2007 outpaced the previous year's USD126.5bn and represent a 54 per cent year-on-year increase. However, the fourth quarter inflow of USD30.4bn was well below the pace set in the first three quarters of the year, making 2007 the third consecutive year to end with a fourth quarter drop in the rate of new capital coming into the industry.
The HFRI Fund Weighted Composite Index returned 1.37 per cent in the fourth quarter and 10.24 per cent for the year. For the third year running, the HFRI Emerging Markets Index was the top performer on an annual basis, adding 3.89 per cent in the fourth quarter, and returning 25.03 per cent for the year. Short selling led all strategies for the quarter, returning 5.94 per cent, but was up just 3.98 per cent for all of 2007.
Relative value arbitrage and event-driven attracted the most new assets in the fourth quarter, bringing in USD9.9bn and USD5.3bn respectively. For the year, relative value arbitrage brought in the most new assets, totaling USD45.9bn. Equity hedge was next with USD41.5bn, although the strategy attracted just USD14m in inflows in the fourth quarter.
Funds of funds saw net new inflows of USD11.3bn in the fourth quarter and USD59.2bn for the year, compared with USD49.7bn in net new assets in 2006 and USD9.5bn in 2005. Globally, USD798.6bn is invested in funds of funds, according to HFR, with total assets invested in the category increasing by almost 22 per cent in the past year. Fund of funds performance was up 1.85 per cent in the fourth quarter of 2007, and 10.12 per cent for the year, according to the HFRI Fund of Funds Composite Index.
'It was another record year for hedge funds when it came to attracting new assets in spite of the slower pace in the fourth quarter,' says HFR's Heinz, who confirms that there are now more than 10,000 hedge funds in the industry. 'The trend in strategy allocations suggests investors are not chasing the best performers, and are anticipating continued opportunities in arbitrage and event-driven.'
Looking ahead, any outflows appear likely to be more than offset by continuing strategic inflows. 'If market conditions remain difficult in 2008, which we think they will, then inflows will remain strong,' says Thomas della Casa, head of research, analysis and strategy at Man Group.
Barry O'Brien, director of business development at fund administrator LaSalle Global Fund Services Europe, also noted an optimistic outlook among hedge fund providers. 'It is very much business as usual,' he says. 'Of course some individual funds have lost their shirts, but that is a cyclical phenomenon. In the late 1990s emerging market funds suffered in the Asian crisis, which was followed by the technology crisis. Certain discrete areas have been severely affected this year, but others are expanding.'
In 2007, market volatility has resulted in a greater variance in the performance of both managers and strategies than in recent years, which for an industry that promotes itself on its ability to generate alpha is a good thing. 'The hedge fund industry fee model has attracted a lot of mediocrity, but the fees are set at levels that are not synonymous with mediocrity,' says Robin Bowie, chairman of Dexion Capital. 'It is now an ideal environment for hedge fund managers to exploit opportunities and show their worth.'
With this greater variation in performance, manager and strategy selection will be even more important than usual in 2008, and there is a renewed belief in the benefits of diversification. 'Achieving a return of Libor plus 500 basis points with a fund of funds is a much better bet than investing in credit at the same level,' says Bowie.
Both Man Group and LaSalle Global have noted a trend towards a greater relative focus on fund of funds rather than hedge funds. 'In 2008, we will see a revival of the diversified fund of hedge funds. In recent years investors wanted high returns, more leverage and specialised exposure. Now they are starting to value diversification more highly again,' says della Casa.
The strategy mix is also shifting to reflect a less benign macroeconomic outlook for 2008. Distressed asset trading, for example, is definitely on managers' radar. Parts of the credit market, such as the industrial segments of the corporate credit market have come under pressure from long liquidation, despite company fundamentals - such as interest cover and cash flow - remaining sound. This creates opportunities for hedge funds to exploit the difference between intrinsic value and oversold market valuations.
Andrew Lodge, managing director of Nedgroup Investments, a fund of hedge funds, aims for a wide distribution of assets across different strategies, but says, 'we do make some tactical asset allocations and we are expecting distressed debt trading to do well in 2008. We are also optimistic about the prospects for funds getting involved in providing mezzanine financing: the banks have pulled back and so the deal flow and value opportunities are improving.'
As well as taking the place of traditional financial intermediaries, hedge funds look set to benefit from greater economic uncertainty. For example, the continuing stress in money markets is a possible threat to strategies in fixed income relative value, but also creates opportunities. 'There are currently very varied opinions about the macroeconomic outlook, which means that price action after central bank policy changes is quite marked,' says Man's della Casa. 'This movement in yield curves creates opportunities to both take profits and enter new trades. Twelve months ago yield curves just weren't moving.'
There has also been a shift of emphasis within specific strategies, such as credit. 'There are three launches that we are aware of in December from managers looking to exploit opportunities in the credit market,' says O'Brien. 'Some areas, such as CDOs have diminished, but other credit-focused strategies have expanded significantly.'
Opinions are more divided on the prospects for quantitative funds, after the very poor performance of several high-profile funds in the first half of August. 'There's an inherent inflexibility in those funds,' says Andrew Lodge. 'There is very little human intervention in the models and they may have had their time.' In November, however, when many hedge fund strategies recorded losses, equity market neutral - in which there is the highest concentration of quantitative funds - recorded a modest gain for the month.
One new area of quantitative investment, however, gained traction in 2007: hedge fund replication. Just as passive index tracking has become an important part of the mutual fund industry, as the hedge fund sector matures interest is growing in low-cost index-based products, which use proprietary algorithms to replicate the performance of hedge funds. Goldman Sachs, JPMorgan and Merrill Lynch have already launched hedge fund 'clones' and the market has also attracted new entrants such as New York-based Index IQ. By definition a passive investment strategy can only replicate beta not alpha. But gaining access at a lower cost to the alternative betas offered by hedge funds - the risk premia earned by isolating asset characteristics that are rewarded - has obvious appeal.
'Passive indexing accounts for about 17 per cent of the mutual fund industry,' says Adam Patti, chief executive of IndexIQ. 'We won't get to an equivalent level in the hedge fund industry next year, but that is the kind of future market growth we are thinking about.' If hedge fund replication does gain widespread popularity, it could lead to downward pressure on fee structures at those hedge funds whose performance is not exceptional.
While it is clear that fund providers are relishing the prospect of more turbulent markets, there are also indications that investor demand remains buoyant - at least for the right kind of hedge fund investment. At the start of December Dexion Absolute, the biggest UK listed fund of hedge funds, raised GBP 460m from investors, which was more than double its original target. 'There is strong demand for good quality funds, which are large and liquid,' says Dexion's Robin Bowie. Some smaller funds, however, have struggled to raise as much capital as they had hoped and there is definitely an element of 'size begetting size' in the current fundraising environment.
It is perhaps unsurprising that in a year during which illiquidity - the inability to sell an asset at the expected price - was the main cause of market distress, investors should show a preference for large vehicles offering ease of entry and exit. However, given the greater variation in performance in 2007, the best managers are finding themselves able to demand tighter, not easier redemption terms. Indeed, some have put forward the argument that very short notice periods added to the summer's volatility by allowing panic withdrawals.
Increased volatility has also prompted a demand from some institutional investors for greater transparency from hedge funds. O'Brien, for example, notes an emerging trend towards managed accounts rather than funds with a unit trust structure. For hedge fund managers there is a fine balance to be struck between meeting clients' requirements and protecting the proprietary nature of trading strategies. It is, after all, difficult to create alpha if everyone knows the exact details of the strategy being followed. In the aftermath of the August turmoil there has also been a greater demand for evidence of sound risk management and valuation processes.
Interest in risk management and transparency was also apparent among policymakers in 2007. Germany used its presidency of the G7 in the first half of the year to press for increased transparency at hedge funds and proposed a global database of hedge fund investments. Recommendations from the Financial Stability Forum, an international grouping of central banks and financial regulators, however, stopped short of calling for tighter regulation.
Germany and others pushing for action, such as the ECB, were mollified by efforts instead to establish a voluntary code of best practice.
The Hedge Fund Working Group, established by 14 leading hedge fund managers based mainly in the UK, this month published best practice standards for hedge fund managers following consultation with the industry and other interested parties.
The publication of the standards has been welcomed by the Alternative Investment Management Association (Aima), which will be involved in implementing them, and follows the issuing of a consultation document by the group last October.
The body of voluntary standards includes recommendations for managers to adopt an independent process for valuing portfolios and to put in hand robust governance of funds, in order to handle conflicts of interest between managers and investors.
The report also recommends enhanced disclosure to investors and urges managers to create a comprehensive risk management framework, an important consideration in the context of financial stability.
The Hedge Fund Working Group was set up last year in response to concerns about both the growing impact of hedge funds and financial stability. The standards aim to address these and other issues through increased disclosure to investors and other counterparties.
'Our final report is the result of extensive consultation within the financial industry, which has helped us to refine the standards and in some important respects make them more rigorous,' says the group's chairman, Sir Andrew Large
'Now it is up to investors to help take this forward. This is a voluntary, market-led initiative based on disclosure. It is the investors who can provide the market discipline to ensure these standards are widely adopted.' Compliance with the standards will be voluntary and will operate on a comply or explain basis.
A Hedge Fund Standards Board is being set up to act as custodian of the standards. The board's trustees will be responsible for updating the standards in the future and for encouraging convergence with the similar initiative currently being taken by the President's Working Group in the US.
Members of the group will initially act as interim trustees of the new Hedge Fund Standards Board and Sir Andrew Large will be interim chairman until permanent trustees are appointed. Aima chairman Christopher Fawcett will become a trustee.
According to the working group, Aima will also have a key role in developing aspects of the recommendations included in the report and in acting as a channel for guidance for the industry as well as consultations on future changes.
The association has welcomed the publication of the report, describing it as 'a substantial undertaking by leading hedge fund managers [that] offers high-level thought leadership on key issues surrounding the industry.
Aima notes that the report endorses its own work in defining and promoting best practice standards for the hedge fund industry and says it will work with the Hedge Fund Standards Board to mesh the standards with its own recommendations.
The association shares the working group's desire to see convergence of the various sets of standards drawn up for the hedge fund standards and has expressed its commitment to leading these efforts, while not underestimating the challenges inherent in doing so. It will consult with its members on the development of the standards by the board and may develop guidance on them if called upon to do so by its members and investors.
'This report is a substantial achievement by this group of leading managers, particularly given the time frame and the market conditions,'' says Aima deputy chief executive Andrew Baker. We believe this initiative is the right approach for the hedge fund industry.
'The working group's endorsement of Aima's leadership and its substantial body of work in industry practices is welcomed, and we are very much looking forward to working with the board and the rest of the industry to oversee convergence of standards.'
The working group was set up last July to address issues raised about financial stability by the G8 and the Financial Stability Forum as well as other concerns about the hedge fund industry. Its terms of reference were to explore a range of issues covering in particular valuation, disclosure of financial information and risk management.
The working group received more than 75 written submissions from interested parties in the industry, its investors and suppliers during the two-month consultation period and held 26 face-to-face discussion sessions.
The members of the group are Nagi Kawkabani, co-chief executive, Brevan Howard; Klaus Jäntti, chief executive, Brummer & Partners; Bernard Oppetit, chief executive, Centaurus Capital; Stuart Fiertz, president, Cheyne Capital; Michael Hintze, chief executive, CQS; Jeffrey Meyer, chief executive, Gartmore; Manny Roman, co-chief executive, GLG; Paul Ruddock, chief executive, Lansdowne Partners; Rob Standing, founding partner, London Diversified; Stanley Fink, deputy chairman, Man Group; Paul Marshall, chairman, Marshall Wace; Michael Cohen, managing partner and chief investment officer for Europe, Och-Ziff Capital Management; Michael Alen-Buckley, chairman, RAB Capital; and George Robinson, founding partner, Sloane Robinson.
The London-centric nature of the working group reflects the city's dominant role for hedge fund management in Europe. According to EuroHedge, UK-based hedge fund managers had USD415 billion of assets under management at the end of June last year, some 80 per cent of the USD539bn in total assets managed or invested in Europe.
The FSF noted in October that, 'The issuance of draft best practice standards…is a notable step towards improved transparency and discipline and a recognition by the sector of its responsibilities as a significant force in the financial system'
Importantly, the FSF has also recognized that this 'significant force' has not been the prime cause of financial market instability in 2007. At the request of the US government the FSF is now studying regulated financial institutions' liquidity, market and credit risk practices.
At the end of a year in which a long expected return of market volatility has tested the resilience of most financial institutions, London's hedge fund industry, with its focus on setting pragmatic best practice standards, is well placed to meet clients' needs in a more challenging investment environment.
-Hedgeweek.com-
Posted by su at 3:24 PM
Hedge funds 'will make double digits'
THE US is already in recession and hedge funds are set to make returns approaching double digits for the second year running, according to the research chief of one of the world's biggest hedge fund groups.
"We are in a recession. It's not a question of whether it's a hard or soft landing, but how long it will continue," said Thomas Della Casa, head of research at British-listed Man Investments.
But he said it would most likely be a short recession, "like the one in 2001", which would be over by the US election in November.
Speaking from his base in Taipei, Mr Della Casa said he believed the equities bear market dated back to November - but it had been overdone given the relative strength of the non-US dollar denominated world economy.
"I would say that the market is as oversold as it was 10 years ago when we entered the Asian crisis," Mr Della Casa said.
"The panic was out there."
Man is one of the top three hedge funds in the world and manages $US70 billion ($80.5 billion).
It operates as a fund of hedge funds as well as running its own quantitative and other hedge funds.
But Mr Della Casa said recent lows could be tested within a few months if more bad news emerged from credit card providers and car loan groups in the US.
He said there were two things hanging over the US economy.
"Consumption will decline by the debt-ridden public (in the US) and a lot of people are scared it will spill over into Asia and China," he said.
Mr Della Casa predicted that growth in China could drop from as high as 12 per cent to 10 per cent or even 8 per cent, depending on how long the recession in the US lasted.
He said the market always looked about six months ahead of economic fundamentals.
But he said the debt crisis was still not over.
In the past week billions of dollars had been written down by major investment banks with more to announce losses in coming weeks.
"I am shocked that the banks do still not have a total look-through in their debt problems," Mr Della Casa said.
"There is still potential that more will come from credit card providers and car loan providers."
He said hedge funds would be wary of current conditions in recent weeks but would start moving into the market now.
"Since the beginning of the year the markets have been extremely difficult - they have been so emotional," Mr Della Casa said.
It had been the worst start to the year for global equity markets since 1932.
"Most of our funds have been holding cash in a neutral position," Mr Della Casa said.
"But they will benefit when the market calms down. You will have seen some activity today but I don't think they have been extremely active over the past few weeks." Mr Della Casa said equity markets tended to start rebounding around the middle of a recession.
"It will be in the second or third quarter and will be before the US election. The US Federal Reserve is supporting that."
He said that last year was the best year for hedge funds since 2003, handing investors returns of 10 per cent or more compared with 3.7 per cent for the MCSI global equities index and 5.3 per cent for bonds. He predicted that with bond markets shot and equities markets in turmoil, hedge funds could again generate double digit returns this year.
-The Australian News-
Posted by su at 3:03 PM
January 17, 2008
More U.K. pension plans In HFs
The number of U.K. pension schemes investing in hedge funds has more than doubled in the past two years, as has the average percentage of assets allocated to them, but still more than 80% continue to avoid them. According to the annual survey by the National Association of Pension Funds, 17% of British defined benefit schemes now put money in hedge funds, up from 8% in 2005 and 11% in 2006, with average allocation invested in hedge funds rising to 1.2%, up from 1% in 2006 and 0.6% in 2005. Even with the boost it trails the rest of the world, where 47% of institutional investors around the world that invest in hedge funds. According to the study, hedge funds gained as pension schemes invested less in equities. At the same time, private equity did not attract any new converts last year, as the number of U.K. pension schemes in remains at 20% for the second year in a row after climbing in 2006 to that mark from15% in2005. NAPF also notes that 4%of those polled now invest in commodities, up from 2% in 2006 and a non-measurable amount before that. Three out of five pension schemes in the Kingdom now invest in property, up from 54% in 2006 and 50% in 2005.
-Hedge Fund Daily-
Posted by su at 10:29 AM
January 16, 2008
Hedge funds achieved more than double equity performance in 2007
The Greenwich Global Hedge Fund Index returned 0.61 per cent in December and 11.15 per cent in 2007, outperforming traditional benchmarks for US, UK and global equities as well as bonds over both the month and year, while the Credit Suisse/Tremont Hedge Fund Index was up 0.47 per cent in December and 12.56 per cent for the year as a whole.
Greenwich Alternative Investments notes that the S&P 500 declined by 0.69 in December and gained 5.50 per cent during 2007, while the MSCI World Equity Index fell by 1.37 per cent over the month but rose 6.49 per cent over the year, and the FTSE 100 returned 0.38 per cent and 3.80 per cent respectively. The Lehman Aggregate Bond Index posted a December return of 0.28 per cent and gained 6.96 per cent for the full year.
'Hedge funds have demonstrated their resilience to downward moves in the equity markets,' says Greenwich senior vice-president Ben Rossman. 'Hedge funds outperformed the S&P 500 by more than 5.5 per cent in 2007 through a combination of capturing market upside and protecting against downside.
'This is hedge funds' highest level of outperformance since 2002, when the S&P 500 was down more than 22 per cent and hedge declined less than 1 per cent. Over the last three years, hedge funds have outperformed the S&P 500 by roughly 2 per cent on an annualised basis, despite the S&P having roughly 50 per cent more risk associated with its returns.'
The Greenwich Composite Investable Index returned 0.27 per cent in December and was up 3.61 per cent for the full year. The Investable Index, comprising 49 constituent funds, adds investibility, active management and liquidity to the diversification and performance benefits of the broad Greenwich Global Hedge Fund Index. It references actual hedge fund vehicles as opposed to separately managed accounts or other methods used to replicate industry returns.
Oliver Schupp, president of Credit Suisse Index, notes that the December industry performance came amid global market weakness and signed of stress in the US economy. 'Global market indices were relatively flat for December,' he says. 'The US continued to show weakness in many sectors as the credit crunch of 2007 continued to affect financial markets worldwide - US manufacturing indicators were at their lowest since April 2003.
'At the December 11 Federal Open Market Committee meeting, the Federal Reserve cut rates for the third straight time and also lowered the discount rate. In the UK, a slowdown in manufacturing growth pushed the Bank of England to cut the benchmark interest rate for the first time in two years.
'Crude oil ended the year at USD95.98 per barrel, a 57 per cent surge over the 2006 year-end figure, and had flirted with the USD100 mark over the prior two months. Overall, this market environment has resulted in eight out of 10 hedge fund sectors ending December on a positive note.'
The Credit Suisse/Tremont Hedge Fund Index comprised 481 funds as of December 31. It is constructed using the Credit Suisse/Tremont database of more than 5,000 hedge funds and includes both open and closed funds located in the US and offshore, but not funds of funds.
To qualify for inclusion in the index selection universe, a fund must have a minimum of US50m under management, a 12-month track record, and audited financial statements. Funds are selected using a formula based on assets under management, ensuring that the Index represents at least 85 per cent of total assets in each of 10 strategy-based sectors in the selection universe.
As well as the Hedge Fund Index, the Credit Suisse/Tremont family of indices includes the AllHedge Index, an investible index comprising all 10 Credit Suisse/Tremont Sector Invest indices weighted according to the sector weights of the broad index, and the Blue Chip Index, an investible index consisting of 60 largest funds across the 10 style-based sectors.
The AllHedge Index was up an estimated net 0.31 per cent in December, while the confirmed performance for November was a decline of 1.18 per cent, leaving the index up 8.82 per cent in 2007. The Blue Chip Index was up an estimated 0.15 per cent net for December, and after a confirmed decline of 1.08 per cent in November, the index gained 7.36 per cent for the year.
-Hedge Fund News-
Posted by su at 1:51 PM
January 11, 2008
Hedge funds up 10.36% in 2007
The average hedge fund managed double-digit returns—just—last year, according to figures from Hedge Fund Research.
The firm’s HFRI Fund Weighted Composite Index returned 10.36% for 2007 after a 0.68% rise in December. Funds of funds trailed, but not by much, adding 9.94% last year following a 0.1% return last month.
As far as individual strategies go, there are emerging market funds, and then there’s everybody else. E.M. blew all other comers out of the water, returning 24.91% on the year (1.75% in December). Funds focused on Asia, in particular, had a stellar 2007, soaring 35.88%. The strategy’s 2.82% December return was also tops among those tracked by HFR.
Energy hedge funds also enjoyed a successful 2007, returning 16.47% (1.95% in December). Technology funds also posted strong returns, adding 15.68% on year, though the strategy fell 0.46% last month.
Speaking of losing, just three of the myriad strategies and sub-strategies tracked by the HFRI indices finished last year in negative territory. Hedge funds focusing on the financial sector suffered the most, as financial firms were battered by the credit crisis and roiling stock markets. The strategy lost 5.88% in 2007, dropping 1.62% in December alone. Real estate hedge funds were pushed into the red by a 2.41% decline last month, leaving the strategy down 1.33% on the year. And high-yield funds finished marginally down, losing 0.14% in 2007 (down 0.05% in December).
Among other major hedge fund strategies, macro funds posted a 12.2% return in 2007 (1.33% in December), while equity hedge funds returned 10.71% (0.68% last month). Relative value funds added 9.35% (0.99% last month), event-driven 7.38% (0.13%), merger arbitrage 6.73% (down 0.67% last month) and distressed securities 6.29% (0.55%).
Equity-market neutral funds were up 5.78% last year (0.78% last month), convertible arbitrage 4.9% (down 0.83% last month) and fixed-income 2.68% (0.23%).
Investable hedge funds did proportionally worse, according the HFR’s HFRX indices. Overall, investable funds returned 4.23% in 2007, declining 0.14% in December. While only one of the HFRX subindices found itself in the red last year—convertible arbitrage, which lost 0.95% for the year after a 2.17% drop in December—just one bettered the Standard & Poor’s 500 Index, which returned 4.9% in 2007. That was relative value arbitrage, which topped all other investable strategies with a 5.8% return, though like most of the HFRX strategy indices, it found itself in the red last month, dropping 0.42% in December.
-FIN alternatives-
Posted by su at 10:19 AM