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Date:25th December 2008 |
Compiled by Mr. M. Sathya Kumar |
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Dangerous
Definitions: Know Your Hedge Funds The hedge fund industry may appear to be a
risky investment choice right now but not every investment instrument
referred to as a 'hedge fund' may necessarily behave according to the true
definition. With a little research, hedge funds can still provide a good
return. On the surface, the hedge fund industry, like telecoms, dotcoms
and banks before it, is now apparently crashing and burning. Schadenfreude
all round, some may say. In recognition of the fact that 'hedge fund' is an unhelpful
modern misnomer in the same way that 'government bailout' is, we might like
to establish some workable definition by which to measure what a hedge fund
actually does. Or, rather, should do. How about: 'Moderately leveraged, bi-directional, speculative trading in
liquid and transparent markets in order to achieve absolute returns unrelated
to traditional asset classes.' This sounds simple enough, so why do most hedge funds have an
in-built directional bias? (Long/short equity? Don't you believe it.) Why do
they put themselves in blatantly illiquid markets and structures such as
collateralised debt obligations (CDOs) and special purpose vehicles (SPVs)?
And how come so many of the strategies are utterly dependent on extortionate
levels of leverage to have any chance of making a return? None of these things should be a problem for experienced,
professional, institutional investors, though. After all, if there is anyone
here that cannot accurately and properly evaluate the ease and cost of
bi-directionality, monitor appropriate leverage, gauge general market
direction and measure market liquidity/transparency in an investment strategy
then they should be reading comic books and not gtnews.com. Right? So how do
these so-called hedge funds rake in so much money? Is it intellectual
intimidation? Is it their celebrity status? Is it a herd mentality? Perhaps
it's the 'greater fool theory' at work? Now we are hearing that there are 'issues' with investor
redemptions at certain hedge funds. That market conditions do not allow for
orderly position liquidation without catastrophic losses. Even worse, there
may be forced liquidations because they can no longer finance their deeply
underwater positions. Well, none of these things can be true, can they? Not if they
were adhering to the very sensible definition of a hedge fund that I set out
above. So whatever they do (did?) and whatever they are (were?), they are not
and were not hedge funds. Not by this definition. As calculated by Hedge Fund
Research, Figure 1 below shows their scorecard for the year-to-date.
These results are not very pretty. It can now be seen that many
of these so-called hedge funds were simply the financial equivalent of wolves
in sheep's' clothing. As such, with 'alternative investments', it is crucial
to know exactly what the instruments are that you are investing in. On the other hand, and in the interest of total fairness, if
investors had the opportunity of swapping their 'traditional asset class'
losses for, say, 20% losses in hedge fund investments, there would be no of
lack of takers: S&P500, FTSE100, Nikkei, (sub)-merging markets.... Need I
go on? Comparative benchmarking aside, it is reasonable to assume that
that most hedge fund investors might be at least a little disappointed and
perhaps even angry to discover that their fund is not behaving in the way
they expected it to. Bad experiences can lead to a negative image of hedge
funds developing in the minds of the investment community. But this would be
a shame for those hedge funds that are strictly adhering to the definition I
gave earlier. Never mind all that though. We now have all these other
alternative investment instruments clambering all over each other in a
scramble for investment. Where do they go from here? What relevance is any of
this to the readers of gtnews.com? The first answer is easy. As before, they will migrate into a
new investment arena and morph into being its undisputed experts. (Of course,
it will have to be one of the few remaining ones that their particular skills
have not yet decimated.) Rest assured, just as the number of new hedge fund
launches exploded following the collapse of global equity markets in
2001-2003, they will reappear within a few years of this debacle, this time
as currency managers. They have not yet destroyed the currency markets because they
were too busy running their multi-billion dollar
market/equity/arbitrage/neutral/convertible/swap/debt strategies. With every
day that passes, more and more of them are finding that they have fewer
billions and more time on their hands. The second answer is also easy. It is relevant to the readers of
gtnews.com because when these currency managers do show up (and they will),
they will appear to be just as fresh and exciting as they were before. And
even more dangerous. Article by Christopher Cruden
began his business career in 1980 as a gold analyst with an investment bank
in South Africa. In 1983 he joined Dean Witter, Reynolds Inc. as a securities
salesman based in the U.S. and it was during this period that he became
involved with the Alternative Investment Industry. In early 1988 he returned
to the UK and became a director of Adam, Harding and Lueck Asset Management
Ltd (AHL). After the sale of this firm to Man International in 1990, he
became head of managed futures and options for a major US investment bank in
London and founded the Derivative Strategy Group within the ASH Group of
Prudential Securities in New York. Cruden joined Tamiso & Co. LLC in 1993
with responsibility for product development and client liaison. During this
period he built the firm's interbank currency management activities and
co-developed the Currency Overlay Program. In 1999 Tamiso and Man
International established a joint venture based around the currency trading
system of Tamiso. Cruden established Insch Capital Management AG in
Switzerland during 2004.
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