The increased correlation between hedge funds and the main markets casts a doubt on the role that these instruments play in investors’ portfolios. Hedge funds have not been immune to the financial crisis: the average global multi-strategy funds of hedge funds lost 18 per cent in 2008, their worst year on record. The fact that mainstream funds and indices registered much higher drawdowns - the S&P global 1200 fell 40.1 per cent last year - has not been of great consolation to those investors who were expecting these financial instruments to deliver the absolute returns they promise.
While large redemptions in the hedge fund industry underline investors’ fear and disappointment, fund selectors and wealth managers remain relatively upbeat.
“Performance should not really alter the definition of what an alternative investment is,” says Paul Marson, chief investment officer at Swiss private bank Lombard Odier. “The role of a hedge fund in a portfolio today should be the same as the desired role of a hedge fund in a portfolio a year or two ago. The reason you own hedge funds is because they are a source of non-correlated alpha,” he says, adding that what investors have found to their cost is that many hedge funds contained a great deal more of “disguised beta”, or equity market returns.
Mr Marson admits that investors now “are less comfortable” with a generic hedge fund. “But part of our job is really to reassure clients that the due diligence that we do is consistent and we are sourcing alpha.”
The strategic recommended allocation to hedge funds has not changed, says Mr Marson, disclosing that alternatives, including private equity and real estate, represent around 20 per cent of an investor’s portfolio at the Swiss private bank.
The robust due diligence process that allowed the bank to avoid the latest hedge fund fraud, in which financier Bernard Madoff has admitted that his seemingly successful hedge fund was in fact a Ponzi scheme, was not able to fully detect the illiquidity issues in the hedge fund universe and the correlation between hedge funds, concedes Mr Marson. “Perhaps, on reflection, what everyone in the industry could have done is to demand a greater transparency, but in a sense the market was not such that would have delivered it.”
Greater transparency
Screening hedge funds today is probably getting easier, says Mr Marson. “We are asking for greater transparency and greater visibility and hedge funds are generally responding to those industry pressures. At the moment, the overriding objectives of hedge funds is to retain assets, and part of the effort to retain assets is responding to demand of greater openness,” he says.
The increasing convergence between the alternative and long only industry allowed by Ucits III is also going in the direction of providing higher standards of investor protection, liquidity and transparency.
If hedge fund firms like GLG Partners and Odey Asset management have been active in the regulated fund arena for some time and their Ucits ranges have attracted strong inflows recently, Brevan Howard, Europe’s largest hedge fund manager with $25bn (E19.5bn), has just launched its first Ucits III absolute return bond fund.
However, while some strategies like long-short, low leveraged macros and long-only convertible can be successfully replicated in Ucits III funds, strategies that involve a significant amount of leverage or a considerable degree of illiquidity face big constraints.
A senior figure at a leading hedge fund group says: “Ucits III is a very big opportunity but it cannot substitute hedge funds. You have a continuum of products that go from long-only to slightly leverage funds, like Ucits III, to hedge funds and they all have different risk returns and characteristics.”
Danger of generalisation
Graham Wainer, group head of private clients and portfolio management at Gam, the asset management arm of Julius Baer, emphasises that there has been a tremendous generalisation about the hedge fund industry as a whole. “Broad generalisations are really not doing justice to the richness of the hedge fund industry.”
General views on hedge funds on performance, correlation, or fees cannot be applied to the entire industry indiscriminately. For example, while long-short equities have been strongly correlated with the equity market, other strategies like discretionary macro or trading funds showed no correlation and have performed well. There are some really talented managers that produced between 8 and 12 per cent last year, says Mr Wainer.
At Gam, which is one of the largest funds of hedge funds players, the allocation to alternative investments that Mr Wainer recommends to private clients and private banks has stayed unchanged.
