Hedge funds not only survived the GFC, but prospered
According to research house Rainmaker Information, Australians had $30 billion invested in hedge funds at the end of 2010, up from $20bn in mid-2007. The sector was hit by the GFC, with investment falling from $27bn to $22bn at one stage, but has roared back (see chart page 7). "It's one of the few segments of the Australian funds management industry where the amount invested is currently higher than it is ever been," Rainmaker head of research Alex Dunnin says.
"Hedge funds would be the fastest-growing sector of the market. The GFC tested the hedge funds pretty severely, but those that passed the test have gone from strength to strength.
"The super funds now have a much better sense of who can run money and which strategies have lived up to the promise of uncorrelated returns; that is, a risk-return outcome that's different from what they get from traditional portfolios based on shares, bonds and property."
To many investors, the term "hedge funds" carries connotations of an ultra-aggressive fund using high leverage to profit from speculative short-term punts: in other words, a high-risk, high-return approach. While some hedge funds do operate this way, Dunnin says it is not a realistic generalisation.
"Hedge funds are simply investment vehicles that use a range of strategies to generate 'absolute returns', positive returns irrespective of the return of the benchmark index for a particular asset class," he says.
Chris Gosselin, chief executive of specialist hedge fund researcher Australian Fund Monitors, says the average hedge fund - of the 230 his firm follows that are open to Australian investors - outperformed the S&P/ASX 200 Accumulation Index (which counts dividends as well as capital gains) by 8.2 per cent in 2010, 27.1 per cent in the three years to December 2010 and 12.3 per cent in the five years to December 2010.
"Whichever way you slice that data, the hedge funds have put seriously strong runs on the board," says Gosselin. "Particularly in the five-year comparison, which takes in the GFC, the hedge funds' strength is pretty compelling."
There are at least 14 distinct hedge fund strategies, but the basic strategies include:
Long/short: going long (buying) in under-valued securities and short (selling) in over-valued securities, particularly shares;
Equity market neutral: a simultaneous long/short strategy that tries to take matching long and short positions in different stocks, to increase the return from making good stock selections, while decreasing the returns from the movement of the broad market;
Global macro: investing on the basis of economic and political events, analysis and forecasts. For example, going long in oil in the belief that Middle East unrest will send the oil price rising;
Tactical asset allocation: researching, identifying and exploiting anomalies in different industries, currencies and stockmarkets, and leveraging into them, using derivatives;
Event-driven: taking advantage of market reactions (specifically, over-reactions) to specific situations, for example takeovers, debt defaults, credit downgrades or even natural disasters;
Commodity trading adviser funds: using quantitative strategies to trade any liquid futures market;
Managed futures funds: using the futures markets to go long (buy) or short (sell) currencies, bonds, commodities, stock indices. Managed futures funds are similar to CTAs, but broader, in that the fund managers could be applying subjective skill as well as quantitative strategies.
Questions and Answers
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