The size of the trust has doubled in the last year, and overseas interest has led to the creation of non-sterling asset classes
Ian Collier, a director at boutique fund of hedge funds (FoHF) specialists Dexion Capital is on a mission. He believes the future for FoHF managers must be closed-ended structures; anything else is just a waste of time.
He has a point - the group's flagship Dexion Absolute investment trust dominates its class and has an unparalleled track record behind it. Investors who want in on the next share issue had better get their skates on.
When it comes to the burgeoning wealth manager market for FoHF, Collier is blunt.
He says: "If you did not invest in a closed-ended fund, men in white coats would take you away. Why? Because you cannot be trusted with the money you are investing for your clients."
Most open-ended FoHF are off limits to even typical wealthy investors, with minimum investments of $1m and as much as $3m. Many wealth managers would struggle to commit that much of their clients' funds and, therefore, a lot of the best FoHF products are the preserve of institutional clients.
That is not the case with Dexion Absolute, the Guernsey-registered closed-ended fund that dominates the sector on the London Stock Exchange.
Because Dexion Absolute is a quoted company, just like an ordinary investment trust, investors can get in with a minimum one share purchase. With the net asset value just under £1.35 at the time of writing, that opens up the marketplace significantly, says Collier.
Not only that, because the fund is the largest quoted trust of its type in London, there are plenty of market makers squeezing the spread and ensuring it is one of the most liquid funds.
As Collier puts it: "If you are in an ordinary [open-ended] FoHF, it could take you as much as three months to get your money. Because we are listed on the London Stock Exchange, you simply ring your broker and get your money within two days."
For UK investors, there is also another advantage to closed-ended funds. Increases in closed-ended versions are treated as capital gains, not income, permitting investors to use up their annual and taper relief allowances.
Collier believes two specific elements of the closed-ended structure employed by Dexion Absolute help allay investor and adviser fears about risk and volatility, built up since the $46bn collapse of Long Term Capital Management (LTCM) in 1998.
First, it is a company, not a fund. As such, it is bound by company and tax law and the requirements of the UK Listing Authority, the FSA division overseeing share listings on the exchange.
It must issue half-yearly accounts, disclose investments and install an independent board of directors. Ultimately though, says Collier, the actions of its investment advisers are controlled by the shareholders.
"It is what the FSA would really want if it ever gets to authorise FoHFs into the UK," he adds.
Second, share prices are easily accessible. That said, the one single criticism intermediaries have about closed-ended vehicles is the mismatch between the continuous share price and monthly valuations.
But, Collier counters: "When it comes to corporate governance, you might get a monthly report from a unit trust manager but, for the most, they do not really want to talk to you directly."
In response to his own question of why open-ended fund of funds even exist, he says: "They are not for private investors in this country, that is for sure. They were built up in the US but I often hear people there say they wish they could buy into FoHFs through our structure."
In the case of Dexion Absolute, the portfolio is managed by Harris Associates, Chicago-based veterans of the FoHF movement. Harris, and more recent players into the market such as Goldman Sachs, like the closed-ended structure for its liquidity benefits.
"It makes it more attractive to them because capital is locked up. This means they can invest in managers who themselves are more locked up with longer redemption periods," says Collier.
Unlike open-ended managers who have to keep one eye on inflows and outflows, closed-ended operators are not affected by changes in share prices because the capital they have to play with remains constant.
Collier says: "The best alpha comes from illiquid assets. This is true of property, private equity and, of course, hedge funds."
The whole closed-ended structure is a win-win situation, he believes: "It is a unique marriage of investors who want liquidity and of managers who do not want to provide it."
Such liquidity and pricing benefits have attracted plenty of potential investors. Private wealth managers including Rathbones, Rothschilds and HSBC dominate the shareholder list. Added to that are several smaller pension funds, which like their investments to be easy to understand.
Balanced funds are eyeing up Dexion Absolute because the daily mark helps their own fund liquidity. The closed-ended structure also helps bring down costs.
"If you invest in a FoHF, the expense ratios have to be shown in the total," adds Collier. "But you are allowed to buy equities and no one would ask you to include the underlying expense ratio of Marks & Spencer or BP. And you do not have to with Dexion Absolute either."
The sector, and Dexion, received a boost earlier this year when the Committee of European Securities Regulators deemed closed-ended funds of this type as transferable securities, which could be included in Ucits type funds.
Insurance companies are also sniffing about. Until recently, the closed-ended FoHF sector was too small for big players to be interested in. Returns would hardly make a difference to their bottom line if they could not dedicate £500m or so, declares Collier.
The Association of Investment Companies puts the market value of London's 14 listed funds, all Guernsey based, at £1.7bn, with assets of £1.64bn.
Under current regulations, open-ended vehicles are not admissible assets for life companies. The rapid growth of closed-ended vehicles means the life sector can now take significant positions.
Collier adds: "Our size almost doubled over the last year. My guess is that life companies will eventually be the biggest shareholder group."
The trust is currently capitalised at £560m, making it a FTSE 250 company. A new stock offer could take that to £800m or more, according to Collier.
Overseas interest has already led to the creation of non-sterling asset classes, following the launch offer in 2002 for just £34m. A further £65m was raised in 2003, £130m in 2004 and a further two issues in 2005 took the fund to current levels. Separate classes now exist for dollar and euro investors.
Dexion Capital likes to think itself different from others in the FoHF arena. Rather than manage the money itself, the company maintains a full research capacity of 500 players in the market and farms out mandates when the right opportunities come along.
"We do not wait for managers to come to us and have us put the right closed-ended structure around them," says Collier. "We wait until we have got the right mandate from clients then go seek the right adviser to do it."
This was the case with 2002's creation of Dexion Absolute. The initial interested shareholder group was presented with a final beauty parade of four FoHF managers, including Harris Associates. Building the mandate and selecting the right manager was a lengthy task, but Harris stood out for a number of reasons.
"Harris Associates has an 18-and-a-half-years' track record, which is enormous in the hedge fund world," explains Collier. "And it has been under the same control, with chief executive Roxanne Martino there from day one. It also has a process it has stuck with throughout."
A fund manager with experience of the LTCM failure and an understanding that arbitrage is not without risk no matter how it seems, were important credentials. But it is the corporate mindset of Harris that sets it apart, says Collier.
He adds: "They are not harvesters of funds. Despite their track record, they are not even in the top half a dozen in the asset management league. They often say no to substantial sums."
To stem inflows and maintain the efficiency of the portfolio, Harris has even upped the minimum on its own flagship fund, Aurora, on which Dexion Absolute is based, to $3m.
The four member investment committee must agree unanimously on any new investment, ensuring rigorous analysis of potential candidates. No prospective manager is ever refused an interview and the team sees up to 500 per year. The US-based Aurora fund invests in around 80 different hedge funds, the Dexion Absolute in 50.
For the Absolute vehicle, the Harris Associates team runs a diverse strategy of eight different 'buckets'. These include events driven and long/short equities, as well as a substantial portfolio hedging operation.
Collier says Harris is the largest allocator to short sellers in the world and, while investors have not seen substantial returns from the strategy, it dramatically reduces risk.
When markets suffer shocks, the short selling strategy can often have negative beta of -1 to -4, a vital prop in maintaining absolute returns.key points
Dexion Absolute is managed by Harris Associates
It invests in around 50 different hedge funds
The trust is currently capitalised at £560m
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