By Neil Wilson
speakers at this years EuroHedge Summit, the European
hedge fund industrys annual gathering in Paris, expressed
marked optimism about the unfolding opportunity for hedge funds
in various asset classes, creating a palpable buzz among the
nearly 900 delegates in attendance.
That said, several other speakers expressed numerous
concerns about uncertainties in the outlook for the future.
These were partly to do with the likely array of new regulatory
requirements facing the industry around the world. But they had
more to do with some deep worries about the global macro
Over the course of the two-day conference, speakers
repeatedly mentioned rising food prices, growing social unrest
and the probability of sovereign debt defaults and/or
At a time of extreme volatility in oil prices and in other
commodity and currency markets, the one thing that came up
again and again was the specter of rising inflation, or the
possibility of a prolonged period of stagflation such as the
one that occurred in the 1970sand how to protect the
value of assets, let alone generate real returns, in such a
If such a period lies ahead, the main question about how to
respondsuperficially, at leastlooks to be about how
much exposure to take to gold. In any period where there is a
loss of confidence in the value of paper money, whether it be
the dollar, euro, pound or yen, gold is usually pointed to as
the most obvious safe alternative, most likely because it has
been used exactly as such a store of value for millennia.
This notion generated a considerable amount of discussion
during the conference. One of the keynote speakers, Colm
OShea of $5 billion macro shop COMAC Capital, struck a
In his Q&A session with the audience, OShea
highlighted that, unlike other commodities, gold is not really
useful at all, in the sense that it is in plentiful supply yet
not used for anything much besides jewelry. Gold is useful, he
pointed out, only if you can use it to acquire things that are
actually practical, such as other commodities that you can eat
or use to generate energy or to produce manufactured goods.
Another keynote speaker, Lee Robinson of Trafalgar Asset
Managers, noted that despite the recent run-up in the price of
gold, the vast majority of investors still have little or no
exposure to it. He argued that investors should have at least
some exposure, though he parted company with the gold bugs on
some aspects of their analysis. Instead, he offered various
option-based trades that investors could deploy as more
sophisticated ways to hedge or play the current market.
While this sort of debate raged over two days, one thing
that Robinson said struck hometo me, at
leastparticularly forcefully: If there is indeed a period
of higher inflation, investors will no longer be looking at
hedge funds in terms of nominal returns, or even in terms of
returns relative to benchmarks such as equity indices.
They will be judging them increasingly in terms of real
returns, relative to inflation, and rightly so.
Robinsons view was that hedge funds, where managers
can undoubtedly deploy a wide armory of investment strategies,
should be better placed to protect investors than other
investment styles and classes.
The best industry to benefit from the investor focus
on real returns is the hedge fund industry, Robinson told
the packed hall of delegates in Paris. We have the tools
and the ideas and the flexibility to make real
Theoretically, that may be the case. But to me it looks like
a significant challenge. Hedging strategiessuch as the
short sides of long/short and arbitrage investingcost
money and tend to flatten returns. That can be effective in
reducing volatility and delivering solid risk-adjusted returns,
as many funds have shown over long periods.
But investors should remember that the last time the
industry went through a prolonged period of rising inflation,
in the 1970s, the vast majority of hedge funds failed to keep
pace with inflation and ultimately failed to survive.
Only a minority, mainly macro players like George Soros who
made the right directional bets, came through successfully. If
the benchmark for success rises from the risk-free rate (which
is now close to zero in most major currencies) to an inflation
rate nearer to double digits a year, it will make a much more
difficult environment for a lot of hedge fund strategies.
Some strategies, such as macro funds or CTAs or volatility
players, may thrive in such an environment. And there may be
deep value that emerges in some equity or distressed strategies
as well. It shouldnt mean the end of hedge funds, because
some managers will flourish and many should still survive. But
its likely to be a bumpy ride.