Hedge funds: An industry reborn?

As a less daunting new breed of fund-of-funds comes to the fore, Charles Stanley’s Kris Barclay examines the pros and cons of their underlying strategies.

Markets ebb and flow, as do new investment ideas. Sometimes, the setting of a new trend might seem a new precedent but, all too often, it is just an old idea reinvigorated. Hedge funds are of that order.

These abstract vehicles have been around for many a year and, of course, the basic and original premise was to hedge one’s assets against the stock market falling.

Long/short single strategy funds were popular through the 1970s and, indeed, today they can work well to hedge against a long-only portfolio of stocks. They came in and out of favour but grew very popular again through the 1990s.

Financial engineers’ creative spirit, fuelled by pension and endowment fund demand, gave rise to a plethora of strategies, all promising to offer returns that would be uncorrelated to long-only books.

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The tools used to achieve the intricate trades were becoming more adventurous. Algorithms encased in black boxes promised to do this automatically. All the while, credit was becoming cheaper and the scale of trades larger.

Whether it was highly leveraged private equity funds that ultimately caused the 2008 crash is irrelevant. The fact remains that those hedge funds with black box strategies largely failed and, worse still, that almost all asset classes falling in tandem meant others did not fulfil their hedge either.

Despite the sector falling out of fashion again, an ever-increasing demand for low volatility returns have created a plateau on which fund-of-hedge funds operate. These broad based vehicles combine a blend of underlying single strategies, the Johnnie Walker of the hedge fund world, so to speak.

Standard Life Global Absolute Return Strategies (GARS) is one of the most popular in the open-ended fund world, while BlueCrest All Blue is one such listed example.

The latter blends its six different disciplines and has achieved returns of some 8.9% since inception in 2006. For the thirstier investor, its underlying BlueTrend strategy had produced double-digit annualised returns but, of course, with greater volatility. It has been a laggard of late with the market showing little sign of direction either way.

 

Global macro

Global macro funds attempt to play world markets, anticipating policy change, economic crises and currency differentials. There are derivations of all of these and, while they may sound brave, in fact many hedge so much of the risk away that they only seek to make marginal returns from each position.

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Others are slightly more aggressive, with directional strategies that snowball returns. Whether on a stock, index or commodity, they often keep doubling up and letting successful positions mount. The Odey house is adept at using principally these strategies to derive its stellar returns.

 

Other strategies

Unlike Odey’s somewhat concentrated fan base, the usual suspects – investment banks and large fund management companies – are always keen to market what they believe to be fashionable at any given point.

There are those that come and go, including merger arbitrage funds, which buy listed companies already subject to a takeover bid, attempting to squeeze a marginal profit when the deal finalises.

Others will invariably create a ‘relative value’ strategy to take advantage of some nuance in the market: it might be exploiting the sustainability of dividends by high yield companies, or a particular type of quirky asset-backed security.

 

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