Funds For All Seasons

Business - March 20th, 1998

Continuing from our last ar­ticle (Feb. 20), entitled “Reap­ing the Rewards From a Volatile Market,” we received many calls from investors asking how they should practically incor­porate funds into their portfo­lio which are not sensitive and hence vulnerable to the stock market downturns (hedge funds) which have caused con­cern recently.

Dictionary definition of Hedge Funds:

All forms of investment funds, companies and private partnerships that 1) Use derivatives for directional investing, 2) And/or are allowed to go short, 3) And/or use significant leverage through borrowing.

In layman’s terms—what does this mean?

Hedge funds look to make returns for investors in abso­lute terms. Whereas an equity fund may aim to outperform its respective index or other comparative benchmark, a hedge fund concentrates solely on net profit to the in­vestor after fees. In addition, fees are heavily reliant upon performance further motivat­ing the managers to find profit opportunities.

How does this differ from the aims of a traditional fund?

A traditional equity fund manager who managed to lose only 10 percent when the stock market index was down 15 per­cent would be heralded as a first class manager. A hedge fund manager who lost money over the same period would be somewhere at the back of the pack.

So “What about my portfo­lio?” Below we have summa­rized the questions asked and answers we give to our inves­tors to provide more of an in­sight into the investment con­siderations.

What percentage of my portfolio should be allocated to hedge funds?

Former research indicates the optimum balance may be a maximum of a 30 percent allo­cation to hedge funds. This however applied to more vola­tile single trader funds. Mod­ern hedge funds however, which may “blend” as many as 20 traders to provide returns from all sectors, are far less volatile to the extent that some have had no losing months for the number of years. Investors using these funds can allocate a far higher proportion of their capital to a safe, non-stock mar­ket reliant strategy.

Which type of hedge funds should I buy?

We recommend principally multi-manager funds with proven consistent track records in line with their stated objec­tives and a well-defined risk pro­file. We are not interested in funds which provide surprises.

Are hedge funds expensive to buy?

The fees associated with hedge funds are principally per­formance-related. Investors wishing to decipher the often complicated fee schedule of multi-manager funds can take heart in the fact the month end reported returns are always quoted net of all fees and charges. Front end fees are usu­ally lower than entry fees on traditional funds and others may have a redemption fee in the first few years, encourag­ing investors to take a medium term view.

Are they really as invulner­able to stock market crashes as they sound?

There is no perfect fund. There are conditions in which hedge funds have losing months, though research shows these are far less frequent than the positive months.

However, let’s take the re­cent “Asian Crisis” as an ex­ample (which in fact became an emerging market crisis). Tradi­tional equity funds diversified in Southeast Asia tumbled 22 per­cent by 1997 year-end, while those invested in Latin Ameri­can stocks saw their portfolios decline 20 percent on the year. The only conventional asset class to post positive returns in October’s meltdown were bonds, as yields fell to 18-month lows on the U.S. 30-year Treasury.

Tass, the hedge fund research group, estimates the 27 dedicated Asian hedge funds it tracks re­turned 4.5 percent for the 1997 year to November. They gener­ally prospered after November, profting from from ongoing vola­tility. Hedge funds with a global mandate had a good year, with returns for the leading “multi-manager” funds we track rang­ing from 14 percent at the more cautious end, to 23 percent for more aggressive funds.

If I move part of my exist­ing portfolio into hedge funds, do I need to think about market timing?

One of the investment max­ims of a hedge fund is that there is never a good or bad time to buy or sell. Due to the diversi­fied trading strategies within the fund, such issues as stretched price/earnings ratios and overvalued markets do not apply. On the issue of the timing of the sale of existing as­sets, there will be additional considerations.

In summary…

The diversification, opportu­nity for profit in all market conditions and reduction in volatil­ity that hedge funds bring to a portfolio make them an essen­tial ingredient. Investors are likely to hear more and more about “alternative strategies” as the world of hedge funds opens up to the private investor. We aim to be at the forefront of this exciting development.

If readers would like a copy of The Tresidder Tuohy Guide to Alternative Investments or more information regarding hedge funds, please call Alison Pockett or David Spratley at Magellan Tresidder Tuohy at 3582-3773.