The safest port in the storm?

Fri Nov 25, 2011

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All the recent surveys indicate that investors plan to put more of their money into hedge funds rather than less


By Nick Evans

Nice as it was – for equity strategies at least, if not for CTAs or macro funds – October’s powerful risk-on rally did not last long.

The ‘new normal’ – of volatile markets and whipsawing investor sentiment – has returned with a bang. And November has been a case of back to business as usual in this exceptionally tough year, with a growing realisation that the extremely challenging and hazardous investment environment could be here for a while.

Far from erecting a firewall to contain the Eurozone financial crisis, all that the European and G20 leaders succeeded in creating was a wind tunnel that fanned the flames from Europe’s burning periphery straight to Italy and Spain – and onto France and other core Europe countries like Belgium and the Netherlands too.

Where and how will it end? All bets are off for the moment. The building is ablaze and the exits are locked – for now at least. Conflict and recrimination are rife in Europe’s ‘union’ and the signs look increasingly ominous.

Meanwhile the US seems stuck in a political and economic quagmire – while, depending on who you talk to, China is either going to be the saviour of the world or the source of its own debt, real estate and shadow banking-fuelled collapse of potentially epic proportions.

So comparisons with 2008 – when what was on the cards was the collapse of the global banking system, prevented only by measures that now appear to threaten the collapse of the global sovereign debt system – are inevitable.

The boomerang is back, big-time. But, for hedge funds at least, the comparison is misplaced: in 2008, investors were trying to run away from hedge funds as fast as they could; in 2011, they seem to be running towards them with increasing speed.

The difference is total. Three years ago, there was a panic-driven dash for cash. Investors, fearing the meltdown of the global payments system, were desperate to liquidate everything they possibly could.

Three years on, with interest rates at zero and inflation rising, cash is not seen as the solution – although a new and potentially worse banking crisis could trigger another stampede. And the prospects for pretty much all asset classes are uncertain at best, with every bit as much downside risk as upside potential.

Instead, what investors are finally waking up to at all levels – institutional, individual and intermediary – is that it is not the asset classes that you choose to allocate to that really matters, but the way in which your money is managed within those asset classes.

So hedge funds, although by no means perfect or socially and politically popular, are increasingly seen as the most likely safe port in a storm that could rage for a long time yet – through which people will have to continue trying to invest and protect their savings and wealth in an increasingly complex and volatile world.

Redemptions and recycling there may be in the short term. That is inevitable. Some hedge funds have done very well. Some have done very badly. That is the nature of the business. But, overall, hedge funds have broadly done what they promise to do – which is to participate on the upside and protect on the downside.

And all the recent surveys indicate clearly that investors are planning to put more of their money into hedge funds (or absolute return funds or ‘active’ funds or UCITS funds or however anyone chooses to market them) rather than less. It may take time. But it will happen.

In a world where all investors are acutely aware that investments can go down as well as up, the good hedge fund managers (whose strategies are driven as much by fear of how much they and their investors could lose as by greed for what they might gain) look like the best guardians of people’s savings and wealth – and their future expectations and obligations.

Whatever hurdles the politicians might erect – through the aimless AIFM directive, the half-baked (although perhaps politically understandable) financial transactions tax, or the absurdly convoluted Dodd-Frank Act – hedge funds will find a way to survive and prosper, although the reality is that any increased costs will simply be passed onto investors, which is the last thing that politicians should wish to engineer.

There are flaws in the hedge fund business model – and there may need to be changes to ensure true and long-term alignment of interests between managers and investors, whose objectives are not always one and the same.

And hedge funds will come and go – as they always have. But, when all is said and done, hedge fund managers generally do well because their customers do well. If the same had been true about the rest of the financial industry, we might not be in the mess that we’re in.