| Hedge Fund Observer: expensive, not performing, and still an investment magnet |
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| 24/07/2005 | |
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Over the course of the last 12 months or so, hedge funds have featured many of the characteristics that should make them unattractive, and yet, have continued to attract investors in droves. An answer to this conundrum might be found in the hedging functions that those funds continue to perform, in spite of not being anymore the glamorous record-making investment vehicles of the past. Take the last release from the Hennessee Group, which announced that its broad-based Hedge Fund Index had climbed 1.50% in June. For an investor being charged an average total expense ratio of 3.94% a year, or about 80% higher than an actively managed fund according to Fitzrovia, the price tag may be too high. One is hastily led to this conclusion by comparing those slim returns against the very reason for which hedge funds have been praised during the 1990s – their out of bound performances in comparison with traditionally managed funds. Should institutions ditch their hedge funds all at once then? So far, the answer from institutional investors has been a resounding no. Why? Hedge funds have achieved to outperform index such as the Dow Jones Industrial Average or the NASDAQ Composite Index since the beginning of the year. All this in spite of a tight equity trading range, a flattening yield curve, and low volatility, which have been impeding most hedge fund managers to deliver high returns, but not to decorrelate their own performance from the rest of the market. Performance gloom For now, pension funds included in a survey commissioned by the financial services group KPMG don't expect the outlook for hedge fund to improve over the coming years, instead expecting bad performance clouds to continue piling up. For those pension funds, the main source of risks is to be found in a hedge fund capacity glut. This overcapacity has two consequences – managers lacking essential hedge fund skills are entering the market, possibly damaging the overall performance of the market as well as being a nuisance to the industry reputation as a whole, while performance sources such as arbitrage opportunities are drying up at high speed. Two out of three of the investors who took part in KPMG's study believe that the overcapacity effect is likely to impact negatively hedge fund performances. And yet, even if the media has relayed various views about impending capacity issues and the possibility of outflows for the first time since the beginning of the 1990s, researchers at Edhec-Risk, a financial consultancy, believe this is all baloney. According to Walter Géhin and Mathieu Vaissié, the authors of a study on alternative betas in hedge fund performance, this is nothing less than a "fantasy": " […] our results suggest that the level of alpha is not bound to diminish significantly as the number of market player increases, provided that the average quality of hedge fund managers remains the same", they say. Given some market developments, there might indeed still be room for market growth and attractive returns. A manager such as Renaissance Technologies, which announced its intention to launch of a multi-billion hedge funds that could be the largest in the world, certainly doesn't expect the market to contract anytime soon. Save if it counts on outflows from bad performing hedge funds to fuel up. J.L. |
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