Hedge funds are no longer the preserve of the rich – they’re good for us all

If you had asked almost anybody in the markets six months ago which bit of the financial system was most likely to trigger a global crisis, it’s a fair bet most people would have pointed the finger at hedge funds.

Secretive, loosely regulated, highly leveraged, far too rich for their own good, hedge funds looked like villains. They almost broke the system in 1998 following the collapse of Long Term Capital Management.

Yet history will show it was not hedge funds but banks that caused the credit crunch. Hedge funds, with a few exceptions, have come through the crisis in good shape. Of course, there have been some anxious moments along the way.

There was the “Quantquake” in August, when a number of so-called quant funds – computer-generated “blackbox” trading systems that rely on complex algorithms to drive their investment decisions – all blew up at the same time. Some, including the Goldman Sachs Alpha fund, lost more than 20% of their value in a few days before recovering. Several credit funds have also been hit by the US mortgage meltdown. Basis Capital in Australia and Sowood Capital in the US have gone out of business. One London-based credit fund, Cambridge Place, had to fire a quarter of its staff this week. 

But by and large, hedge funds have come-of-age during this crisis. So far, most have done what they are supposed to do: provide consistent returns independent of what is happening in the markets. Despite a difficult month in August, the HFRI index of hedge-fund returns bounced back nearly 3% in September leaving it up 9% on the year. From what I am hearing, October returns are also likely to be strong. Some hedge funds have done incredibly well from the crisis, including Paulson, a New York-based fund that has made more than $3bn from betting against subprime mortgages. No wonder a recent hedge-fund conference opened with a session rather triumphantly titled “the crisis that never was”.

The industry really took off during the 2000 to 2003 bear market, when stockmarkets were tumbling and investors were clamouring for funds that would preserve their capital rather than simply track the market downwards. Market volatility is good for traders, who depend on price swings in any direction to make money. Choppy markets also throw up pricing anomalies within and between markets, which savvy hedge funds, with their broad remits, are better able to exploit than most. And as more risk-averse investors fall away, those with the guts to take big bets on market events, such as mergers going ahead, will find the odds lengthen in their favour.

The difference between now and the previous bear market, however, is that this time anyone can get access to a hedge fund. Six years ago, they were the exclusive preserve of the very rich. Typically, you needed at least a million pounds in the bank and had to be willing to make a minimum investment of about £100,000 to get access to a decent hedge fund. But these days, you can choose from more than 50 hedge funds listed on the stockmarket. These funds are just like old-fashioned investment trusts. They are independent businesses whose sole asset is a pool of money that is invested on the fund’s behalf by a top hedge-fund manager. The share price is determined entirely by the performance of the assets in the fund.

The beauty of these funds is that you can buy and sell the shares on the stockmarket at no cost other than usual brokerage charges. There are no long lock-ups, quarterly redemptions and all the other restrictions of traditional hedge-fund investing. They are perfect for retail investors, yet retail investors hardly ever hear about them – perhaps because funds do not pay financial advisers chunky fees. Yet they provide investors with access to some of the smartest investment talent around.

For example, BH Macro, a fund managed by London-based hedge fund Brevan Howard, has consistently returned more than 2% a month through the credit crunch, betting on global interest rates and currency moves. MW Tops (TOPS), managed by Marshall Wace, has an ingenious equity trading system that has consistently outperformed the FTSE100.

Alternatively, you could opt for a fund of funds, which invests across a range of hedge funds. Two of the best-established of these are Dexion Absolute (DAB) and Absolute Return Trust (ABR). Of course, no hedge fund is completely risk-free, particularly in a credit crunch. But as we’ve recently discovered to our cost, nor is a bank.

Simon Nixon is executive editor of Breakingviews.com


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