Why hedge funds can give us the clearest insights

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The Independent Online

One of the great paradoxes of the way that we invest money professionally in this country is that those who are best placed to spot and act on the long-term trends that ultimately determine investment performance are required to spend most of their time trying to identify and chase short-term price movements instead.

One of the great paradoxes of the way that we invest money professionally in this country is that those who are best placed to spot and act on the long-term trends that ultimately determine investment performance are required to spend most of their time trying to identify and chase short-term price movements instead.

Keynes likened the business of investment management to a beauty contest, in which the judges are engaged not in choosing the girl they think is the prettiest, but the one they think their fellow judges are most likely to choose. If the telecoms, media and technology sector rises 50 per cent in six months, as happened over the winter of 1999-2000, then woe betide the professional fund manager who knows that it is all a fad and that saner counsels must eventually prevail.

If he fails to go with the crowd, his short-term performance figures will suffer and all that year's new money from investors, which is highly correlated to where the action has just been, rather than where it may be in the future, will go elsewhere. Only the bravest or most independent money managers can afford to buck the economic imperatives of the industry, which favour fashion-chasing over the pursuit of longer term moneymaking insights.

Yet just because almost all money managers have to play the relative performance game, it does not mean that their insights are either wrong or wasted. The paradox of the past few years is that the flow of talent into the money management business has been growing just as the scope for managers to exercise their discretion has been reducing, thanks to five years of predominantly momentum-driven markets.

The most compelling arguments for looking at hedge funds as a way of investing, in my view, are not the ones that are often deployed in their favour, such as their low correlation with mainstream markets, the ability to go short as well as long, and so on. Rather it is that they mostly require the managers of the fund to put their own money where their mouths are, and reward them accordingly. With a structure of this sort, which equates the interest of the manager more closely to that of the investors, you are more likely to see your money invested in accordance with the way the manager really thinks the world is developing, not just in the way that others have decided it seems to be going. You are also more likely to find the manager enthusiastically engaged in his (or her) day-to-day job if he is free to back the judgements you are paying handsomely for.

When tracking the views of professional fund managers, in an effort to spot future emerging market trends, I have certainly found that it pays both to spread the net as widely as possible and to discriminate heavily between those who can and those who cannot afford to manage their funds in accordance with their personal convictions. Hedge fund managers feature disproportionately in this list, though they too are by no means immune to performance pressures, in this case largely driven by the inflated expectations of their investors as to the scale of the returns that are realistically achievable.

One fund manager who has given me a lot of valuable insights over the years is Crispin Odey, whose flagship European hedge fund Odey European, after an adventurous first few years at the riskier end of the fund spectrum, has matured into one of the best and most successful of its kind, with excellent risk-adjusted returns. He and his management colleagues still own about 16 per cent of the fund, which takes long and short positions in equities, bonds and currencies. It is up 261 per cent over the past five years against a benchmark return of 161 per cent, a compound annual return of 29.3 per cent versus 21.2 per cent.

What I like about the Odey approach to fund management is that it combines short-term trading insights with a keen awareness of some of the deeper trends that have driven the development of financial markets over the past few years. You may not agree with everything that he has to say, and inevitably not all his trading calls turn out to be right, but I have never failed to be stimulated by the lively and amusing way in which his ideas are presented. It makes a refreshing change from the well-rehearsed marketing spiel that passes for market commentary at many conventional funds.

The interesting thing Odey has to say today is that while he has made a fair bit of money out of shorting the most overblown TMT stocks since the bubble burst last March, and has been generally bearish for two years, he expects the rally in the TMT sector that began in the new year may persist for some time, helped by the aggressive monetary easing that Alan Greenspan has clearly now embarked upon.

His view now is that Greenspan's proactive approach, assuming it is endorsed by the rest of the Fed, and the more ponderous approach of the European Central Bank, "could generate the first chance to make serious money in currencies since 1994". A policy of "long euros, short long bonds, long TMT equities, with a watching brief on commodities, is all the advice necessary for getting through the first quarter of 2001".

The chances are high, he thinks, that we will now see: "1, markets rally on the back of further interest rate cuts; 2, economies avoid recession - for now; 3, the euro rise above 1.15 to the $; and 4, inflation re-enter the debate." This last point, however, is the key to the more important issue of what happens in the longer term.

Odey's longer term perspective is that the great bull market we have enjoyed since the early 1980s has been made possible "because Volcker, Thatcher and Reagan broke the link between wages and inflation", which meant that gains in productivity have accrued primarily to savers rather than to consumers (and led to the current hegemony of the bond markets over governments). But how will it go now? Will Greenspan vote for slightly higher inflation or another severe recession? Odey's answer is the former, as only that way can Greenspan get rid of "the unholy mountain of debt" that is now choking the economic system in the United States.

* My thanks to readers who have been in touch with me about my recent column on events at Equitable Life, and in particular the case for a negotiated settlement. I hope to return to this subject next week.

In the meantime I suggest readers who want to keep up to datewith events use the websiteequitablelifemembers.org.uk as a starting point, and follow the many links to the sites of the various action groups, and other useful sources of information.

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