Most people find hedge funds difficult to comprehend, says Paul Burgin, but they can provide many ad...
Most people find hedge funds difficult to comprehend, says Paul Burgin, but they can provide many advantages for investors
There are plenty of people in this world who will never understand hedge funds. There are also plenty out there that pretend they do. Being one who understands hedge funds and can explain them well to clients marks out the most competent and dedicated of advisers. But, intermediaries face a steep and almost impossible learning curve if they want to be one step ahead of the burgeoning fund of hedge funds (FoHF) market.
Justine Fearns, research manager at adviser AWD Chase de Vere, says the majority of multi-manager hedge funds are set up offshore for tax reasons.
She says: "It is not the easiest situation for investors to understand and they have to be careful about what they choose and why they want them. Funds tends to have distributor status, but those that do not are marginally less preferable for income seekers."
She says a lot of interest is coming from investors wanting to put their FoHF investments in offshore bonds or self-invested pension plans (Sipps), which are taxed differently in each case.
Ian Collier, director of Dexion Capital, parent group of the Guernsey-registered Dexion Absolute closed-ended fund, says the structure has another advantage. Most FoHFs are off limits to even typical wealthy investors, with minimums of US$1m and up to as much as US$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.
But, because Dexion Absolute is a quoted company, just like an ordinary investment trust, investors can gain entrance with a minimum one share purchase, which opens up the marketplace significantly, says Collier.
Not only that, because the fund is the largest quoted in London, there are plenty of market makers (around nine at present) squeezing the spread and ensuring it is one of the most liquid funds in its class. 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 out. However, because we are listed on the London Stock Exchange, you simply ring your broker and you get your money in two days."
Whatever structure they take, Fearns says comparing FoHFs is no easy task, not surprisingly as by their very nature, each will invest across a range of managers, each of whom will employ a vast array of strategies to produce absolute returns. Trying to track funds against a benchmark can be a futile exercise - each tends to choose its own for comparison's sake and many are obscure and unknown to UK investors.
While absolute returns are the name of the game, it can be tricky to form a clear view of which funds perform better in adverse conditions against main traditional markets in equities and bonds.
Comparing performance against cash focuses on absolute returns, although investors do need to be wary of time periods. Obtaining a deeper view on how underlying funds and strategies perform is tricky because FoHFs and hedge funds tend to be far less transparent than regular funds than most investors are used to.
Fearns says: "The hedge fund world is notoriously closed and the people running the underlying funds are really the rocket scientists of the investment community. They tend to be on a completely different level to your ordinary adviser."
Some advisers are concerned about the difficulties in assessing the underlying holdings of a FoHF. When markets wobbled in May and liquidity dried up in equity markets around the world, long-only managers were quick to blame hedge funds for all rushing for the door at the same time, making a volatile situation even worse.
Earlier this year, the European Central Bank (ECB) also warned investors about the dangers of hedge fund investing and, in particular, about the recent trend towards equities adopted by managers.
In its Financial Stability Review, published in June, the ECB said: "The increasingly similar positioning of individual hedge funds within broad hedge fund investment strategies is another major risk for financial stability, which warrants close monitoring despite the essential lack of any possible remedies. This risk is further magnified by evidence that broad hedge fund investment strategies have also become increasingly correlated, thereby further increasing the potential adverse effects of disorderly exits from crowded trades."
Fearns says getting to grips with the whole market is a full-time job, something few advisers can afford to do. Information is not always easy to track down, unless advisers invest in complex databases, often costing thousands of pounds per year, making it uneconomical for most.
FoHFs are still highly geared towards the institutional market, making access for advisers more complex than for standard long-only UK-based funds. Fearns adds: "A lot of them are worth a lot of money too and they do not always have the time nor inclination to talk to minnows like me."
According to figures collated by Man Group, the rapid growth of the hedge fund industry to around 9,000 funds and $1.3 trillion under management has been fuelled mainly by institutions. Well over half the funds are less than five years old and the top-100 managers account for more than 50% of funds under management.
Man Group is one of the leading players in the retail market, with private investment representing 60% of its funds under management. Banks account for more than half of all private investor sales, with intermediaries and brokers taking a 29% share, up from 21% last year. The group recently completed a $2.3bn launch, a record for global private investor hedge funds.
Although Fearns admits groups such as Man and Matrix are opening up the market and ensuring their FoHF managers get out and meet key advisers, she says networking is the only real way to find out who does what and who does it well.
She adds: "The other thing to be wary about is how often investors can get in or out of a fund. Some are going back to half-yearly or even annually, but you can understand that."
With the hedge fund market so heavily geared to institutional, a lot of funds have large blocks of money in their portfolios. With underlying hedge funds investing more and more in locked-up assets for better returns, liquidity would be an issue if daily pricing were the norm.
Fearns says: "They have exclusive clients that they need to protect, they have to protect precious egos too. Restricting flows in and out of the funds is a key part of the process."
When looking at hedge funds and multi-manager variants, the only solution is to read every bit of documentation and to ensure you have the time to do it, thinks Fearns. Prospectuses can run to hundreds of pages and involve highly technical jargon.
For retail-friendliness, Fearns recommends the Matrix funds, particularly the multi-strategy Horizon and the Max, run by Sandra Manzke. Income seekers will do well to look at Ermitage Asset Selection, a multi-arbitrage fund, while those wanting to protect their investment should read up on the Permal Global Long Short fund.
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