Secrets Of Success: Hedge funds prevail despite losses

You can be sure that an asset class has arrived in the mainstream when it gets to feature in the agenda for a meeting of the G8 world leaders. So this weekend, although most media attention has centred on poverty and Africa, it is safe to say that any lingering doubts that hedge funds are here to stay have finally been extinguished, as long predicted in this space.

In the past month, no less a collection of luminaries than the German Chancellor Gerhard Schröder, the chairman of the Federal Reserve Alan Greenspan and the head of the European Central Bank Jean-Claude Trichet have all chimed in on the subject. The main debate is whether or not the rapid growth in hedge funds has contributed to an increase in risk in the financial system.

The Bank for International Settlements has also chipped in its twopenny worth in its annual report. While it may not be quite the publicity that hedge funds need, being fingered as a potential source of a breakdown in the global financial system underlines how far this new medium of investing has come in the last five years. There is no question that they are here to stay.

It is ironic, but not at all surprising, that the growing acceptance of hedge funds by institutions and individuals alike has coincided with a downturn in their overall levels of performance. A number of funds, as I predicted a few weeks ago, have thrown in the towel, either because of unacceptable levels of losses or simply a failure to produce adequate results. Both trends are signs that the market is maturing after a period of rapid growth: some analysts even suggest that the inflow of money into hedge funds may even have gone into reverse for the first time this year.

This is what Greenspan had to say on the subject of hedge fund performance last month. "Most of the low-hanging fruit of readily available profits has already been picked up by the managers of the massive influx of hedge fund capital, leaving as a by-product much more efficient markets and normal returns. These entities have been able to raise significant resources from investors who are apparently seeking above average risk-adjusted returns, which of course can only be achieved by a minority of investors."

That is certainly part of the story, though as the market analyst Peter Bernstein notes in a recent economics and strategy newsletter, it may not be the growth in the number of hedge funds that is leading to more efficient markets (and therefore lower returns) in their specialist areas. It might be (and he thinks is) the other way round: it is the general efficiency of markets that is helping to produce the disappointing returns that many funds have been experiencing to produce.

As always with discussion of hedge fund activity, it is dangerous to generalise, as the specific market niches in which many funds operate are so very different. In some cases, the problem facing hedge funds may be simply that the opportunity they have been exploiting (say a certain emerging market's debt) has simply disappeared. For other funds looking to exploit short-term trading strategies, such as convertible arbitrage, the opportunity seems to have been temporarily competed away. In other areas, many hedge funds continue to produce good performance figures.

What is certain is that investors are starting to wise up to the fact that putting money into hedge funds is not the one-way bet it may have seemed.

The general marketing drive behind the growth in their business has tended to emphasise the apparent low-risk nature of hedge funds, with their stated objective of pursuing absolute (rather than relative) returns, and low correlations with other asset classes. Quite a few hedge funds are so low-risk that they barely seem to be alive at times.

Yet other funds, including some of the bigger names that have run into difficulties this year, have made some surprisingly high monthly losses this year, emphasising the inherent riskiness of their strategies, often the result of using leverage to inflate returns. When you are paying such handsome fees for performance, such big losses are doubly unwelcome, which is one reason why hedge funds' assets tend to dry up very quickly when they have a poor period. The money drains away like sand, implying that many hedge fund investors, whatever they might say, are actually looking for short term rather than long term returns.

Few names can consider themselves exempt from investor fickleness. GLG Partners, one of the biggest in Europe, founded 10 years ago by three partners from Lehman Brothers, is said to have suffered large withdrawals from two of its 14 funds. Like a number of other funds, and the trading desks of the large investment banks, the funds in question seem to have got themselves the wrong side of some leveraged trades in credit derivatives, with costly results. The same goes for the Bailey Coates Cromwell Fund and Aman Capital, which have both closed down after suffering losses and a consequent large wave of investor selling.

In both these cases, the managers involved had good track records and lots of relevant experience. This only underlines a painful fact of market life. While it is true that many of the most talented investment managers are leaving conventional fund management houses in order to set up hedge funds, it does not follow that all hedge funds will perform as a result.

That is because talent alone is not enough for success in any field of investment. The reason good fund managers like hedge funds is that it gives them an opportunity to make a lot of money very quickly and to do what they do best with the minimum of constraints. But even the best cannot escape the harsh truth that the markets routinely make fools of even the best and the brightest talents. While hedge funds are here to stay, it doesn't change that fact.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

Finacial products from our partners
Property search
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    SThree: Graduate Recruitment Resourcer

    £20000 - £22500 per annum + OTE £30K: SThree: SThree Group have been well esta...

    Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

    £24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

    Ashdown Group: Business Analyst - Financial Services - City, London

    £50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...

    SThree: Trainee Recruitment Consultant

    £18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...

    Day In a Page

    Not even the 'putrid throat' could stop the Ross Poldark swoon-fest'

    Not even the 'putrid throat' could stop the Ross Poldark swoon-fest'

    How a costume drama became a Sunday night staple
    Miliband promises no stamp duty for first-time buyers as he pushes Tories on housing

    Miliband promises no stamp duty for first-time buyers

    Labour leader pushes Tories on housing
    Aviation history is littered with grand failures - from the the Bristol Brabazon to Concorde - but what went wrong with the SuperJumbo?

    Aviation history is littered with grand failures

    But what went wrong with the SuperJumbo?
    Fear of Putin, Islamists and immigration is giving rise to a new generation of Soviet-style 'iron curtains' right across Europe

    Fortress Europe?

    Fear of Putin, Islamists and immigration is giving rise to a new generation of 'iron curtains'
    Never mind what you're wearing, it's what you're reclining on

    Never mind what you're wearing

    It's what you're reclining on that matters
    General Election 2015: Chuka Umunna on the benefits of immigration, humility – and his leader Ed Miliband

    Chuka Umunna: A virus of racism runs through Ukip

    The shadow business secretary on the benefits of immigration, humility – and his leader Ed Miliband
    Yemen crisis: This exotic war will soon become Europe's problem

    Yemen's exotic war will soon affect Europe

    Terrorism and boatloads of desperate migrants will be the outcome of the Saudi air campaign, says Patrick Cockburn
    Marginal Streets project aims to document voters in the run-up to the General Election

    Marginal Streets project documents voters

    Independent photographers Joseph Fox and Orlando Gili are uploading two portraits of constituents to their website for each day of the campaign
    Game of Thrones: Visit the real-life kingdom of Westeros to see where violent history ends and telly tourism begins

    The real-life kingdom of Westeros

    Is there something a little uncomfortable about Game of Thrones shooting in Northern Ireland?
    How to survive a social-media mauling, by the tough women of Twitter

    How to survive a Twitter mauling

    Mary Beard, Caroline Criado-Perez, Louise Mensch, Bunny La Roche and Courtney Barrasford reveal how to trounce the trolls
    Gallipoli centenary: At dawn, the young remember the young who perished in one of the First World War's bloodiest battles

    At dawn, the young remember the young

    A century ago, soldiers of the Empire – many no more than boys – spilt on to Gallipoli’s beaches. On this 100th Anzac Day, there are personal, poetic tributes to their sacrifice
    Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves

    Follow the money as never before

    Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves, reports Rupert Cornwell
    Samuel West interview: The actor and director on austerity, unionisation, and not mentioning his famous parents

    Samuel West interview

    The actor and director on austerity, unionisation, and not mentioning his famous parents
    General Election 2015: Imagine if the leading political parties were fashion labels

    Imagine if the leading political parties were fashion labels

    Fashion editor, Alexander Fury, on what the leaders' appearances tell us about them
    Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

    Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

    The architect of the HeForShe movement and head of UN Women on the world's failure to combat domestic violence