Money: Over a hedge into a pool

By PHILIP MACALISTER

The idea of calling an investment fund a hedge fund is a bit odd. It sounds like you are trying to keep people out.

But hedges have been effective in the retail investment scene for years, and now there's clear evidence the barrier is coming down.

Hedge funds are now all the rage, so much so they could be renamed swimming pool funds - everyone's jumping into them.

Some of the swimmers are natural water babies, while others just wallow.

The reason hedge funds have become popular is simply that they are supposed to make money even when everything else is sinking.

With markets drowning in red ink, it is easy to see why people are sprinting towards alternative investments.

In the American market, the rush to hedge funds is like the start of a swimming race where everyone dives into the water at once.

It is estimated that one new hedge fund is started every day there. And the industry is reporting stronger growth than the mutual fund business.

US research company Cerulli Associates says hedge fund assets grew by more than 44 per cent from 1998 to US$450 billion.

It estimates there are more than 6500 hedge funds around the world.

New Zealand hasn't been well served by the quantity of hedge funds on offer. Several fund managers have tried to entice investors into their pools, but only two have had any success.

The big fish in this pond are Tower Managed Funds, with its GAM Multi-Trading fund, and OM Strategic (formerly Ord Minnett).

Tower has plugged away with its fund since 1994, and in recent times has enjoyed considerable support.

Tower Managed Funds general manager distribution Richard Baker says the fund was one of the company's top two in terms of money flow in the three months to June. It now has about $123 million invested in it.

Likewise, OM Strategic has been hugely successful in getting New Zealanders to invest in the first eight series of its OM IP 220 funds.

These are closed-end Australian-domiciled funds that invest in hedge funds and have a capital guarantee.

Although OM Strategic has never disclosed how much money it has taken, the most recent offering this year is thought to have raised about $40 million from New Zealand investors.

OM Strategic director Gary Gerstle says the company has raised about $A800 million for its funds in the past four years, and New Zealanders contributed a disproportionately high percentage of that money.

Others companies have either just started funds or are on the edge of taking the plunge. Among these are Deutsche Asset Management, AXA, FGI Asset Management, Frank Russell and Challenger.

One of the big problems with hedge funds is describing what they are.

To most people, the name "hedge fund" throws up bad memories such as the failure of the $US100 billion Long Term Capital Management fund in 1998.

But such failures, while large and headline grabbing, are not the mainstream hedge fund investment.

Hedge fund is an umbrella term which includes just about anything that isn't mainstream - the name has become interchangable with other descriptions, such as trading funds.

One of the key elements which distinguishes hedge funds from traditional funds is their use of what are known as long and short investment positions.

Most investors are familiar with the concept of a long position, as that is what most traditional share fund managers do. They buy a stock (or take a position) when they think the value of a share will rise.

But hedge funds can also make money while stock prices fall, by using derivatives.

For example, a fund manager decides the price of a certain share, which he does not own, will fall in the next two months.

He makes a deal to sell the shares now, but to deliver them to their new owner in two months.

If everything goes according to plan, the share price falls, the fund manager buys enough shares to make the delivery and is left with a profit on the deal.

This is known as selling short. Deals like this are called derivatives because they derive from a real asset - a share.

Hedge funds can use this technique to reduce the risk and increase the returns on their investments.

Typically, hedge funds will adopt both long and short positions and are therefore called long/short funds.

But several other hedge fund strategies use different combinations of derivative contracts and/or asset classes.

Macro funds are probably the best known, and have the worst reputation. These are the funds, like George Soros' Quantum fund, which make big bets on global economics.

Their notoriety is earned from instances such as Britain's exit from the European exchange rate mechanism in 1992, forced out by the huge positions taken by currency hedge funds. Soros is widely thought to have made $US1 billion from Britain's embarrassment.

What makes hedge funds so attractive is that they offer an opportunity to achieve capital growth whatever the market conditions, while keeping risk under control.

Although hedge funds have been around since 1949, they are only just making their way into the retail market.

Tower's Richard Baker says that because of their complexity, and the existence of "equivalent or superior substitutes" - such as international and US share funds - in terms of risk and returns over recent years, investors looked past hedge funds.

But now, because the world sharemarkets have been going backwards for nearly a year, attention has focused on investments which will make money in a falling market - hedge funds.

The growing popularity of hedge funds also represents a further maturing of the New Zealand investment scene.

Mr Baker says maturation goes through several phases. The previous one was the acceptance by investors and fund managers that they needed to invest a significant portion of their money overseas.

The next one, he says, is that more sophisticated funds, such as hedge funds, will become a regular part of a diversified portfolio.

Current thinking is that hedge funds should not be used in isolation. Rather they are an optional part - perhaps up to 10 per cent - of a portfolio.

OM Strategic's Mr Gerstle says the rise of hedge funds isn't a fad or a trend.

"It's ... the beginning of a trend that will grow and strengthen over the next 10 years."

Once you've jumped the hedge and found the pool on the other side, things look OK.

* Philip Macalister is the editor of online money management magazine Good Returns. His e-mail address is philip@goodreturns.co.nz