Hedge funds - unpacked

Nedcor Retail Investments (NRI) hosted a workshop to look at the local and international hedge fund sector.

In the first part Jason Huemer, president of Synthesis Funds, in New York, reviewed the hedge fund industry and what has happened in the past 18 months, and looked at which of the strategies worked and which didn't work.

A lot has happened, as 2002 wasn't a nice place and time to be to be in. Most operators were recoding their first down year. A lot has changed.

Shortly

In a nutshell, the industry has grown unabated, from around $30bn in assets in 1990 to just over $800bn last year, while the performance of hedge funds on the CSFP Tremont hedge fund index returned 15.4%. People have voted with their wallets - institutions and individuals.

Sectors that stood out last year saw macro stage a comeback, currently sitting at 19% of the total allocated capital, while emerging markets had the strongest performance, it lost ground on a relative basis, and owned just 1.6% of the capital.

The old stalwards, distressed and equity long/short also performed well, but there were capital outflows. The worst performing sector was the sector-specific strategy, which includes mutual fund timing, which saw capital outflows of 50%, and virtually disappeared overnight, with many scandals and jail terms.

Some lessons learnt

"There is an interesting learning experience here that we can all learn from."

Heumer said that there have been some lessons learnt. "Styles can be highly cyclical, as is the industry, seeming to move in four-year cycles, and value is not necessarily superior to trading or growth.

He maintains that the strength of a hedge fund is the ability to preserve capital, in difficult times.

"Keep in mind that managers usually have an embedded style bias, which they may not even realise, and this is often skewed towards value."

This is a critical mistake, says Heumer. Value is not always the best investing style, but the comfortable way, as it resonates with most investors. You may make money over time, but if you want to make money every year then its time for a change.

Any solutions?

"The trick would be to find a manager that can make money in any market. Alternatively understand the bias in your portfolio, and re-balance."

The big trades of 2003 centred on gold in the macro strategies, returning 17.99% over three years.

"Gold surged (long gold), largely due to hedge fund buying. While the other big trade was on the dollar (short dollar) as it plunged on low rates and declining confidence."

Event driven strategies had a good year, with the distressed sub strategy performing the best compared to the risk arbitrage and event-driven strategies. Distressed is a relatively new strategy. People who got out in US summer of 2002, made a big mistake. Cyclicality is the order of the day here, says Heumer.

On the fixed income side, Heumer says that credit strategies have enjoyed a good run, but interest rates will rise and added to which the spreads have gone from wide to too tight.

The future

Looking ahead he maintains that growth and institutionalisation will continue with the related positive and negative consequences.