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Australian hedge funds surge as investors chase performance

A staff reporter

13 February 2005

Investment in Australian hedge funds has doubled over the past year amid volatile equities markets, though perhaps more due to their popularity among retail investors than the traditional high net-worth individuals. According to new figures from Rainmaker Information, the financial services analysts, investment in Australian hedge funds surged from $540m in September 2001 to $1.1bn this year. Chris Page, managing director of Rainmaker Information, told Private Client Management the growth was coming from both private clients and institutional investors — with both categories becoming a lot more discerning in their investment decisions. "You'd have to say hedge funds are going through a rebirth at the moment, after a long lead time. There's been renewed interest as people are looking at ways to achieve investment returns in a fairly volatile market. Nowadays there's a raft of hedge funds on offer and the question's more like, 'well, what sort of a hedge fund strategy are you going to choose?' The hedge funds will give you a whole range of investment strategies: arbitrage; event-driven; direction/tactical; and multi-strategy, which is basically a combination of the first three," Page explained. "I guess it's difficult for us to say exactly where the growth is coming from — you'd have to say it's coming from the retail sector. So that's broadly described as the 'mum and dad' sector. But I'd also suggest there's a renewed interest from financial planning advisers who are scrambling to find ways to bolster the performance of their clients' portfolios. So clearly what a lot of financial planners will be finding is that they have a number of clients who are underwhelmed by the performance of global equity markets at the moment, so they're looking for ways to enhance that and clearly hedge funds or derivatives are a way of boosting their performance in difficult times." A main driver of the recent growth in Australia is the emergence of 'listed absolute return funds' — otherwise known as listed hedge funds. On 18 September, Absolute Capital introduced the first of these products, listing three hedge funds on the Australian Stock Exchange. These funds can be traded in the same manner as ordinary shares of listed companies, which increases their appeal to less affluent investors. In the past, Australian hedge funds generally had a minimum investment threshold of A$1m. Other exchanges with similar listed hedge funds include the London Stock Exchange, Irish Stock Exchange, Kuala Lumpur Stock Exchange and Euronext. While the US has an estimated $270bn invested in hedge funds — largely from HNWs — the tax and regulatory system there makes it unlikely that funds will go public. Kris Vogelsong, head of product development at the ASX, told Private Client Management that the new listed funds in Australia were helping to boost the appeal of hedge funds across the investor spectrum. "I think listed funds appeal to all investors right across the board from institutional investors to private client investors. I'd liken them to a certain extent to property trusts, which appeal to the same range of investors. While the investment techniques and the asset class and all of those other investment fundamentals are entirely different — you wouldn't substitute a hedge fund for a property trust — I think as investment products they have a role which spans all investors. For instance, CalPERS in the US is the largest pension fund in the world and the largest hedge fund investor in the world. Then a large part of the market comes from the private client investors who are looking to diversify their portfolio," Vogelsong said. Of course, with the increasing popularity of hedge funds, there's an increasing possibility that investors — many of them new to absolute return funds — will be unprepared for the associated risks. Page said there was still some confusion in Australia over the level of risk attached to hedge funds. Part of the problem is that they are so heavily dependent on the performance of the individual fund managers, rather than the general flux of the stock market. "I guess another part the confusion comes down to what people really define as risk. What we really mean by risk is the volatility or standard deviation of a particular return. So may say the strategy is low risk, however, you are trading in derivative markets which by their nature are highly volatile. So high volatility means high risk in investment speak," Page said. He added that both newer retail investors and more seasoned HNWs were equally prone to 'getting burnt' when playing with derivatives. "Absolutely, high net-worth people have been burnt playing the derivative markets and will continue to be burnt. All we need to mention is Long-Term Capital Management in the US, the billion dollar hedge fund that collapsed. Today's hedge funds here are fund of funds, where they're managing a group of hedge fund managers. Typically, they're grouping them together under those four headings: arbitrage, event-driven, direction/tactical and multi-strategy. So what the hedge funds are offering here is professional management of those markets — and those risks." In practice, absolute return funds employ a variety of strategies and can range from the conservative to the aggressive. It is a misconception that hedge funds are only concerned with high-risk speculation on currency values, volatile markets, interest rate movements and commodities. Vogelsong, while maintaining there were inherent risks involved with hedge funds, said they would continue to grow in popularity. Even events such as the 1998 near-collapse of LTCM would not prevent that. "I think that hedge funds will continue to have a role in people's portfolios, largely for their diversification attributes. If you look at the growth trend, since 1992 the assets in hedge funds have grown every year — and that's despite some of the incidents such as Long-Term Capital Management. Even in 1998, when LTCM blew up, the dollar allocation to hedge funds increased. So I wouldn't see any reason for that not to continue — not for the foreseeable future anyway."