Hedge funds: here for the long haul?

To many people in the funds management industry, hedge funds are analogous to what Kylie Minogue is to the music world or Brad Pitt is to movies — cool and sexy.

However, despite all the discussion surrounding these ‘hip’ alternative investments, and the fact that no one doubts hedge funds continued ascent onto an increasing number of trustee, individual investor and research house (and in turn adviser) radars, are they here to stay?

According tovan Eyk Researchmanaging director Stephen van Eyk, the past three-and-a-half year period, which he says is the second longest in history apart from the Great Depression in which defensive assets have consecutively outperformed growth assets month on month, has led to increased interest in alternative investments such as hedge funds.

“With investors having gone through this period, it’s certainly increased investor appetite for more defensive assets, as they’re starting to think that this market behaviour is normal and that equities are never going to go up again,” he says.

“So you’re seeing more interest in hedge funds, private equity and basically anything that isn’t associated with traditional liquid markets.”

However, this is not to say if and when markets recover for a prolonged period that investors will then desert hedge funds, van Eyk argues.

“I don’t think markets are going to do so well that people will abandon hedge funds, as they offer diversification and provide a portfolio with lower volatility, or Sharpe ratio,” he says.

According to Pengana Capital managing director of hedge funds Damien Hatfield, many people in the industry feel hedge funds have only had a mediocre year, despite a misplaced understanding that they will shine in down markets.

“The industry as a whole [however] was not negative and most funds invest long in fixed interest and equities — assets classes that were under extreme pressure,” Hatfield says.

“I think the retail hedge fund offerings are now going to start attracting a significant amount of money. In addition, you’ve got more research houses rating individual hedge funds and fund-of-funds and making recommendations to dealers, which will increase interest quite dramatically,” Hatfield adds.

Van Eyk, while agreeing with Hatfield, is more of the belief that hedge fund growth in terms of attracting assets will slow.

“The amount of growth they’ve experienced will moderate, however, there is a long-term position for them [hedge funds] in portfolios, as I don’t think we are ever going to see the sorts of prolonged 15 per cent per annum returns we’ve experienced over the past 20 years.”

Van Eyk says for more than a decade falling inflation and interest rates were responsible for 6 per cent of the annualised returns investors were experiencing.

This cannot continue, with van Eyk predicting interest rates will slide sideways with a slight upward inclination in the foreseeable future.

While hedge funds tend to have higher management fees, there is unlikely to be any downward pressure going forward, according toBT Financial Grouphead of alternative strategies Richard Keary.

“The nature of hedge funds in general is that the supply of good quality hedge funds is less than demand and that environment is not one in which you get pressure on fees.

“In fact, good hedge quality funds are even rationing themselves by extending their liquidity provisions, that is, they may have longer lock-up periods than previously,” Keary says.

Rather than fees per se, Keary believes one issue facing investors is making sure they are hiring a hedge fund manager.

“There are managers that call themselves hedge funds but don’t really do too much hedging. They essentially offer long-only strategies, but charge the higher level of fees associated with hedge funds.

“It’s a question of disclosure and it’s up to investors to decide whether they’re prepared to pay the fees they’re being asked,” Keary says.