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Hedge funds - good or bad?

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by Peter Switzer

In the whole scheme of things the bad guys in life are obviously mass murderers, criminals, terrorists and hedge fund managers. Right? Afraid not. I recently talked to a hedge fund expert who not only thinks hedge funds are good for returns but also aren’t as volatile and as risky as most of think.

The expert is a bloke I have known for years and he has had a lot of experience in the markets. He has always seemed sound of mind and I don’t think that has changed.

His name is Chris Gosselin and he runs a business called Australian Fund Monitors, which surveys the performance of absolute return funds or hedge funds. He makes the point that not all hedge funds are the same. Some are more risky than others, some are big return machines, while others are big losers at times. However, there are a lot that make good returns, relatively safely.

Hedge against calamity

On my program, SWITZER, on Sky News Business Channel, he showed how the average of hedge funds performance was better overall than the ASX 200 index, which most conventional investment funds try to beat and are happy if they match it.

Gosselin showed that when the market boomed, the funds underperformed; but when the market crashed, he proved the average of hedge funds performance was better. There’s a sound reason for this as hedge funds get their name from the idea of hedging against a market calamity or a move against your position in a market.

For example, some really active savvy investors might take an option, which means they will make money if the stock market tumbles. This will cost them money if the market doesn’t tumble but that would only happen while they are making money from the rising market. It’s just like insurance.

Snapshot

Australian Fund Monitors released its recent snapshot of returns and this is what they found:

In September 2009, the average return was +2.34 per cent, year to date it was +14.75 per cent and for the past 12 months, the figure was +6.17 per cent. At the same time the ASX 200 registered +5.90 per cent for September, a big +27.43 per cent for the year to date and +3.10 per cent for past 12 months.

On a full-on rally situation, comparison with a conventional fund that is long only equities, if it matched the ASX 200 performance, hedge funds ran second on a September and year to date basis. However, over the 12 month period hedge funds did +6.17 per cent compared with +3.10 per cent on the ASX 200.

On this criteria, the hedge funds could claim that they had a better performance and had half the volatility.

Fair question

As a consequence, Gosselin asks the fair question: “Do hedge funds deserve the bad name?”

On that criteria. they don’t. But on others, you could say they have a capacity to work against the common good and therefore need to be checked at certain times. This becomes a philosophical and economic equity matter but I think hedge funds simply have to understand that sometimes the majority will stop them making money because there are catastrophic consequences.

Short sellers

For example, when they engaged in short selling, wrapped up with false rumours that crippled companies, threatened essentially sound companies, along with people’s jobs and families, then the rules of the trading game needed to be changed.

The world basically accepted this when governments of the world stood behind banks to prevent a Great Depression, effectively arguing that their banks were too big to fail. Anyone with a job nowadays should be happy about this intervention, which might have cost some courageous short sellers a packet!

Do the research

When considering hedge funds, you must fully understand them and how they make money and what can go wrong. You need to understand how much your investments should be exposed to them. As a group, they are not the baddies they have been made out to be.

One area that has spooked investors is where they stop withdrawals to save the fund from being driven into bankruptcy. Many of these funds will become normal again but their actions would worry many a cautious investor.

Gosselin's top ten hedge funds

The Ascot Fund (15.36 per cent return)
Austral Equity Fund (13.57 per cent return)
Macquarie Special Events Fund (12.8 per cent return)
Herschel Absolute Return Fund (18.81 per cent return)
Regal Amazon Market Neutral Fund (24.28 per cent return)
Bennelong Securities Long Short Equity Fund (23.33 per cent return)
GlenBridge Australian Equities Fund (23.52 per cent return)
Fortitude Capital Absolute Return Trust (11.03 per cent return)
Lanterne Ailsa Fund (12.63 per cent return)
WaveStone Capital Absolute Return Fund (16.07 per cent return).

For advice you can trust, contact Switzer Financial Services.

Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Wednesday, November 18, 2009