Has market volatility increased opportunities for hedge funds?

The Association of Investment Companies (AIC) recently hosted a press roundtable lunch on the investment company Hedge Fund sector with BH Marco and Tapestry Investment Company.

The Hedge Fund sector has become one of the fastest growing AIC sectors in recent years, accounting for 23% by value of all investment company sector new issues last year and making it the 4th largest AIC sector with assets of over £6.6bn.

So far the AIC Hedge Fund sector has held up well to the principle of absolute returns over the last year of volatile markets, up 8% compared to a 9% fall in the wider investment company sector. However, with some high profile failures in the wider hedge funds arena, and the continuing credit crunch, can the sector continue to thrive?

The prevailing mood was one of optimism, with managers suggesting that the credit crunch has created increased buying opportunities positioning the sector well for long-term absolute returns.

However, that's not to say that managers believe Hedge Funds are without risk. For example, commenting on the wider hedge funds arena, Anthony Culligan, Manager of F&C Event Driven, points out that some hedge funds which held similar assets to those being sold by the banks have been hurt, but he believes opportunities for the Hedge Funds investment company sector are "more abundant than ever". Interestingly, Ian Plenderleith, Chairman of BH Macro, believes that hedge funds are currently enabling markets to find a trading level where there is a resumption of genuine two-way business, better liquidity and a return to properly-functioning financial markets

Fund Manager Quotes

Anthony Simpson, Co-head of Global Business Development at Ramius, managers of Tapestry Investment Company, said: "As markets evolve through this crisis period and return to some form of equilibrium, there will be substantial opportunities to generate good risk-adjusted returns. Precise timing of these events remains uncertain, but institutions continue to increase their allocations to hedge funds."

Ian Plenderleith, Chairman of BH Macro said, "The severe disturbance being experienced in financial markets reflects a complex of different factors, which coming together make it peculiarly hard to read the way forward. One factor is the major adjustment taking place in risk-pricing and the dislocation this has created in core markets in credit risk and liquidity. But on top of this there are effects from a cyclical slowdown some of the major economies were already facing and the continued working-out of global imbalances already evident in the world economy for the past several years, as well as an apparent shift in the demand/supply for oil and soft commodities.

"All of these adjustments, and particularly the process of re-pricing risk, create opportunities for hedge funds who are prepared to back their own judgement of where they may feel the markets have not yet reached appropriately priced risk. Macro funds like BH Macro are particularly well placed to take advantage of these opportunities. By careful research and analysis of opportunities in the volatile market environment of recent months, BH Macro has indeed been able to achieve a very strong performance. Importantly it should be recognised that, in engaging with these opportunities, hedge funds are also contributing to the wider public policy interest of enabling markets to find a trading level where there is a resumption of genuine two-way business, better liquidity and a return to properly-functioning financial markets."

Anthony Culligan, Manager of F&C Event Driven said: "The credit crunch essentially means there has been a sharp contraction in bank balance sheets. Banks, by their nature, are leveraged entities and contracting balance sheets means they have had to sell assets to reduce leverage. Some hedge funds which held similar assets to those being sold by the banks have therefore been hurt.

"Opportunities are more abundant than ever. In senior debt there are top teens returns to be reaped very high up in the capital structure. At the other end of the seniority scale, the equity of high growth franchises can be acquired for single digit PE's and double digit yields. The hedge fund sector is positioned for a supercharged two year return run."

James Glover, Client Portfolio Manager for JP Morgan Progressive Multi-Strategy Fund Limited said, "Recently we have seen extremely volatile and testing market conditions across not only traditional asset classes but also in alternative classes. PMSF has shown that by targeting similar levels of return across the underlying asset classes the benefits of diversification, in both equities and hedge, in turbulent market conditions have been considerable. This is a challenging market but we take a long term view on investing where we look to maximise growth and have confidence in this outlook."

Mark White, Chief Executive at KGR Capital, who specialise in Asian Hedge Funds and are Advisers to KGR Absolute Return commented: "Asian hedge funds have survived the credit crunch reasonably well as they do not generally rely heavily on high levels of gearing to achieve their returns. The more challenging conditions have provided good opportunities for managers employing strategies that are non-directional in nature: event driven, arbitrage, and equity market neutral strategies have all produced positive returns. We expect to see a further shift away from long/short equity strategies which have traditionally dominated the Asian hedge fund universe."

Annabel Brodie-Smith, Communications Director, AIC said: "At a time when investors are increasingly looking towards alternative asset classes, the Hedge Fund investment company sector has become a real growth area in the investment company sector, quickly becoming the AIC's fourth largest sector.

"Whilst it's important to start with a balanced portfolio first, investment company Hedge Funds can really enhance diversity, and the listed structure of the closed ended Hedge Funds investment company sector means investors have access to a wider level of transparency than they otherwise might. Hedge Funds are also available through self select savings and ISA schemes so they suit a variety of budgets.

"Of course this is still a young sector, so long-term performance records are not available for the majority of Hedge Funds investment companies. Whilst there are some single strategy Hedge Funds in this sector, most are fund of Hedge Funds. Investors need to do their homework to make sure they select the right fund for them in this diverse sector and if they are unsure they should take independent financial advice."