ONE BIG PROBLEM FOR THE HEDGE FUND SECTOR:

THEY'RE AN EASY TARGET

It seems most people's opinions on hedge funds generally fall into one of two categories: Firstly there are those who claim to understand them, and frequently criticise them in the process, and secondly there are those who admit they don't understand them. The problem is those in the second category tend to listen or believe the opinions of those in the first.

And the problem for the hedge fund industry is that as a whole it's an easy target, as the funds that make up the sector is extraordinarily broad and diverse. As a result finding hedge funds or hedge fund managers who fit the negative stereotype is not difficult, in part because they're the ones who get most of the publicity.

I have to admit to potentially being a little biased in the good vs. bad hedge fund debate, and even if I'm not most readers will assume that I am anyway. However it is worth pointing out some facts about the hedge fund sector, while at the same time accepting the reality that not all of them are perfect, and only a minority are truly "best of breed".

So firstly let's look at what makes up the universe. ASIC in its Regulatory Guide 240, is quite clear and correct when it states that there's no firm definition of a hedge fund, but provides a range of features which it uses to identify them. These include a more complex investment strategy that aims to generate returns with a low correlation to equity and bond indices, the use of derivatives such as futures and options, the use of leverage or borrowing, the use of short selling, and finally the charging of a performance based fee in addition to a management fee.

Using the above five criteria when evaluating the performance of hedge funds creates a wide range of funds to choose from, each of which might invest in completely different asset types such as equities, bonds, credit, commodities or currencies which would normally not be associated with each other, and therefore rarely compared.

Adding to the complexity for the casual observer is that there are over twenty different strategies that a fund manager might use. And within each strategy there are further sub strategies or styles to complicate the analysis further. For instance if we just take those funds investing in equities, the www.fundmonitors.com database divides the universe up into eight further sub strategies or styles.

To make matters worse it doesn't end there. Even taking equity long/short, (the most popular equity type strategy) there are funds which specialise in specific market sectors, such are large cap/small cap or industrials vs. resources. Some go further and focus on small cap and emerging resource or gold stocks.

Styles differ also - quantitative and discretionary, as does the geographic universe or mandate which might cover Australia, Asia, Asia ex Japan, Europe or the US - and so it goes on.

The point of detailing all this is that the term "hedge fund" casts a very wide net indeed, and frequently there is little to no comparison or correlation between one end of the spectrum and the other.

The same can be said of performance, and indeed it is worth noting that one of the objectives of hedge or alternative funds for institutional investors is to diversify their exposure to a specific asset class so that when one (such as equities) performs badly others (such as bonds or commodities) provide some protection against the volatility.

Read the entire article by Chris Gosselin here.

ATTACHED FILESOne big problem for the hedge fund sector (pdf format)

Sell in May and go away? That all depends where you're going.

With just one trading day to go, May has been an interesting month. The sharp contrast between the fall in the ASX200 of -4.33%, and the S&P500's gain of 4.08% is a significant differential of 8.41%.

Although the overall fall on the ASX200 has been significant (although smaller than May 2012 when it fell over 7%) the variance between sectors will also make a big difference to this month's fund and strategy performances.

The contrast will be even more glaring when comparing returns between funds investing in Australia, and those with offshore or global mandates.  Partly or un-hedged international funds will benefit from the decline in the A$ of 6.7% during May from US$1.036 to US$0.967 which pushes the return on the S&P500 in $A terms to 11.15%. This brings the potential difference in returns between local and un-hedged US equities to 15.48%.

This raises two points of interest. Firstly the volatility of monthly returns recorded by the ASX over the past 12 months, with moves ranging between +5.37% and -4.43%. 

Secondly and looking forward, is the outlook of the ASX and the A$ given the deterioration in sentiment.  Most Australian  investors, both individual and institutional, have a strong bias to domestic  rather than global equities which has worked well until 2008.

However with local interest rates forecast to fall further, the A$ is expected to have further to fall, and the earnings outlook for the domestic market is deteriorating on the back of contraction in the mining sector. Meanwhile the medium outlook for consumer related companies has deteriorated, even if the yield argument may keep the (expensive) banks, Telco's and REITS supported.

While offshore markets in each geography have their own problems they may be further into a recovery at a time that Australia is moving into a slower growth situation. In this environment, investors may need to consider their asset and strategy allocation as the long only and index funds which have performed so well over the past year make way for more risk averse investments, or include the option of funds with offshore exposure.

Performance and News Updates on www.fundmonitors.com this week:

The BlackRock Multi Opportunity Fund had a sound April, returning 1.69% and 10.86% over the last 12 months.  Their latest Fund Review is available here.

SGH Ice Fund, a small cap manager, delivered 2.57% during April and 28.53% over the preceding 12 months. 

Mathews Capital Velocity Fund redemptions have been frozen for 12 months. Perpetual Trust Services, the responsible entity of the Velocity Fund has advised investors that the fund has become "non- liquid" and that redemptions will be suspended for up to nine months.

And finally, for something completely different, a funny look at insurance company decision making policy.

On that note, I hope you have a happy and healthy weekend!

Regards,

Chris
CEO, AUSTRALIAN FUND MONITORS

Connect with me on LinkedIn Twitter Facebook

Skating on thin ice:

My old friend Patto was the master of market sayings which became known to those who followed him as "Pattoisms". One of his favourites was "when skating on thin ice, the speed at which one has to skate is directly proportional to the thickness of the ice."

Markets have seemed a bit like that this week. In the US the ice appears to be very thin every time Ben Bernanke goes off cue and suggests that QE might end at some stage. The ice in China appears thin whenever the numbers indicate growth might slow below 7%. And in Australia it seems that without the mining and resources sector, we are skating on thin ice as significant parts of the rest of the economy (manufacturing, retail) are struggling.

Over the past couple of weeks the ice actually cracked under those companies whose earnings are reliant on the mining sector.  In the last couple of days it seems that even the yield driven rotation into the banks might also be on thin ice.

April Fund Performance:

Close to 90% of single funds have now reported April results as follows:

From a Strategy perspective the best performances are:

Performance and News Updates on www.fundmonitors.com this week:

The BlackRock Australian Equity Market Neutral Fund had a sound April returning 2.18%, bringing its 12 month return to 8.71%. The portfolio benefitted from the resource under performance due to a tilt toward producers versus explorers, with significant contribution coming from short positions in Kingsgate Consolidated, Newcrest Mining and Oz Minerals, amongst others. The yield theme also proved profitable via our exposure to property trusts and telecoms.  

Pengana Australian Equities Market Neutral Fund delivered -0.9% for April and has an annualised return of 8.82% since inception in September 2008. Two of the largest long positions in April were BC Iron and Skilled Group, while two of the largest short positions were Macquarie Atlas Roads Group and AWE.

The 8IP Asia Pacific Partners Fund delivered -1.17% during April bringing its six month performance to 21.57%.  After five months of strong gains, a number of stocks in the Fund ran into profit taking. Largest sector exposures were financials, real estate and consumer discretionary.

Allard Investment Fund recorded 0.80% over April with it's since inception (July 2003) performance at 8.49% pa. At end-April the asset breakdown was 68.6% equities and 31.4% cash and fixed income. The geographic breakdown was HK/China 32.1%, Sing 12.4% and Korea 9.3% with other countries at lower percentages.

The Pengana Asia Special Events (Onshore) Fund returned 1.31% during April and had a twelve month return of 8.23%. The Fund maintained an average net and gross exposure of 16% and 164% respectively. Largest month end net exposures were China, Japan and Indonesia and biggest gross exposure by strategy was Merger and Acquisitions. April was very eventful led by a significant pick up in M&A activity and the earnings seasons in some markets. Japan was the most active M&A market in Asia, accounting for 6 of the 14 new deals during the month.

And finally, for something completely different, the latest Evian commerical, also featured on Alan Kohler's Eureka report (if you are not a subscriber, I recommend it) last week.

On that note, I hope you have a happy and healthy weekend!