By Colin McLean, managing director of Scottish Value Management There has been little to encoura...
By Colin McLean, managing director of Scottish Value Management
There has been little to encourage equity investors in recent months. Even many of the technology and smaller company shares that rallied sharply after September have now given up their gains.
Yet, some advisers are actually looking forward to their next client meetings. Those who finally made the move into hedge funds last year have generally achieved absolute gains. The work it took to understand this specialist sector and identify clients who could take advantage of it is paying off.
The hedge sector's statistics are impressive. More than £15bn of new money was raised last year, with some 147 new funds launched in Europe alone. And, offering a more realistic entry point for those new to the sector, a number of funds of hedge funds (FOHF) were launched.
In theory, these diversified funds provide an attractive entry point for those unfamiliar with the complex world of hedge funds. They aim to pick performing managers and achieve a good spread of those. In practice, some have been dull.
Advisers and clients should not complain about FOHF investments that went up while stock markets collapsed but the actual returns achieved last year ' averaging around 4% ' disappointed many people. It seems that many funds of hedge funds have not been adept enough at spotting winners.
There were wide variations last year in performance. The best hedge funds in 2001 tended to be those that benefited from stock market volatility, such as convertible arbitrage and from the better performance of bond markets.
By comparison, much lower levels of takeover activity created a difficult background for funds specialising in merger arbitrage. Also, many hedge funds in the equity long/short area were disappointing. It seems that the current environment requires a greater focus on stockpicking. Funds that had performed well in 1999 and early 2000 ' when new issue profits were available, or sector rotation and market direction were easier to call ' seem to be struggling now in the volatile markets of the last 18 months.
It is clear, therefore, that investors need to be selective with hedge funds. Areas that are producing good results can quickly suck in new money, forcing down returns. Advisers need to gain some experience with FOHFs before they tackle the tricky area of manager selection themselves.
It is important to be selective even in this type of fund to avoid those delivering low returns currently. There is a danger that a recovery in the world economy could quickly see money rushing back out into conventional equity investment.
However, there are some strong points in favour of hedge investment. In directionless stock markets, it makes sense to allow a manager to make money from falling share prices as well as rising ones.
And, some of the best managers of conventional funds are moving into hedge funds. Advisers may wish to follow their favourite managers.
The overcapacity problem should also sort itself out ' funds that fail to achieve critical mass within two years tend to disappear quite quickly.
Hedge funds proving resilient.
Some of best managers setting up funds.
Choice increasing as new funds launched.
Some fund of hedge funds dull.
Expertise needed to pick managers.
Need to avoid current fashions.
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