When does a fund become a hedge fund? Hedge funds have existed for many years, but the definition is...
When does a fund become a hedge fund? Hedge funds have existed for many years, but the definition is still evolving and the boundaries between long-only and hedge funds are becoming increasingly blurred.
Typically, hedge funds are thought of as esoteric and rather secretive investments used by the ultra-wealthy. They aim to deliver returns irrespective of stock market conditions through the use of sophisticated instruments such as derivatives.
The introduction of wider investment powers under the Ucits III regime means long-only funds can use some of the methods and instruments that have traditionally belonged to their hedge fund rivals albeit in a limited way. Certainly, this offers many advantages to the long-only funds as derivatives can be used to manage risk.
New funds have launched to take advantage of these powers. Merrill Lynch Absolute Alpha, managed by Mark Lyttleton is one such example.
And it is not only new launches taking advantage of added flexibility afforded by Ucits III. Fidelity Special Situations, managed by Anthony Bolton, is one of the most widely held funds among private investors, yet this is converting to the Ucits III regime, enabling the manager to make use of this greater flexibility, such as shorting an index.
Jorma Korhonen, manager of the Fidelity Global Special Situations fund, which is to emerge following the split of the UK Special Situations portfolio, also intends to add value beyond holding 'long-only' stocks by using Ucits III powers.
Yet these are not hedge funds, Fidelity would stress. The reason why not, according to Fidelity, is that they intend only to use these powers to a small extent. Certainly there is no dispute that Fidelity knows what it is doing, but where do you draw that line between hedge funds and otherwise?
Another way boundaries are breaking down between hedge funds and traditional long-only funds as we know them, is through the introduction of performance fees on the latter. Certainly, a feature of hedge funds has been that investors' interests are aligned with that of the manager. Now, with more long-only funds offering performance fees, which certainly have their place, another distinction is lost.
Grey areas have existed for some time when it comes to hedge funds. Another example is that distressed debt investing was not considered hedge fund investing until relatively recently. That is because distressed funds typically do not hedge their investments. They do, however, seek absolute returns and are generally rewarded on that basis. Such issues over this blurring of boundaries has been raised in the FSA's discussion paper entitled Hedge Funds: A Discussion of Risk and Regulatory Engagement.
Investors want fund providers to be innovative and provide profit-making opportunities. But, as Francois Barthelemy, a partner at F&C's fund of hedge fund business, argues by putting a legal definition on hedge funds, there is a risk that managers would be boxed into a particular range of activity.
Insisting that providers declare themselves as hedge funds in order to use just one or two techniques would probably be a barrier to a number of them - thus stifling the mainstream adoption of these useful investment methods that can add substantial value to an investor's portfolio.
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