An article by Tony Boyd in Saturday's AFR bought up the key words of "hedge funds" and "insider trading" which is always good for a headline if nothing else. The Article was focused on ASIC's concern that some investors might be trying to access broker research on specific companies prior to it being released to all clients, and thus being generally available.

This has some serious implications especially as a number of overseas funds have been caught up in insider trading investigations, most recently SAC Capital in the US where an individual is under investigation by the SEC, which has resulted in redemption notices for over $1.7bn being lodged by the fund's external investors. That's a significant chunk of external money, which reportedly only makes up about 50% of the total external FUM - the balance being internal - founders' and staff.

Back to the AFR, where the article focused on a large global, offshore fund trying to access a broker's research prior to general release. As an ex broker I can recall plenty of instances of some investors knowing what's in the research pipeline, and there's obviously a grey area between company information, and broker disseminated information. There's no doubt that large institutional investors, including hedge funds get access to information not generally available to retail investors, whether by their added research capacity, or by investor briefings directly from the company itself, or through broker presentations.

This became more and more of an issue as institutions established formal broker panels post the '87 crash, with a heavy weighting to the quality of individual research analysts as part of the process. Meanwhile many institutional fund managers promote the number of company visits they make each year as one of their key strengths. Even though they may not be provided with what might be conventionally termed inside information, they are certainly ahead of the information curve compared with retail investors.

The difficulty here is how strictly to draw the line between "dodgy, and deliberate" inside information, such as that being investigated over option trading in Heinz's stock prior to last week's proposed acquisition by Warren Buffett, and "general information" provided by brokers or management.

The reality is that institutional investors, hedge funds or otherwise, will ALWAYS be at an information advantage. They have the resources to analyse research, they often have access to company management, and they certainly get first look at placements, which are often only offered to institutional and large shareholders. So where does one (or in this case ASIC) draw the line?

Of course anything "deal" related is over the line, but at what point does "unfair" advantage come in. If I go out onto the footy park (not a good sight), or a fun run (what's fun about a fun run?) there are plenty of other competitors (usually 99% of them) who have an advantage over me courtesy of age, training, excess alcohol intake (mine not theirs) not to mention the use of supplements or even legally prescribed peptides.

I'm all in support of transparency and a level playing field in broker research, but it is incredibly hard to define, and harder to enforce.

The Australian equity market rally has now seen the ASX200 rise over 8% YTD, and 26% over the past 12 months, driven not only by the rotation out of cash and term deposits which drove the high yielding banks higher, but more recently also into previously unloved discretionary consumer and retail sectors.

As a result some of the concentrated, high conviction funds which had struggled over the previous 3 to 4 years have enjoyed stellar, above market performance. Meanwhile the risk averse long short and market neutral funds which had previously protected investors' capital have struggled to find value at current prices. This has been further exaggerated by some aggressive price moves amongst their short positions where valuations have been stretched even further.

In this environment active and absolute return funds as a whole are likely to underperform, as indicated by the table below based on 53% of funds which have to date reported January results:

These are averages, and there have been some significant outliers. 21% of funds in the AFM index outperformed the ASX200's return of 4.95% in January, and 35% have achieved this over the past 12 months. Conversely, 11% of fund returns for January to date have been negative, while 14% have returned negative performances over the past 12 months.

The improved performance and sentiment is welcome, but following 7 straight positive months, and gains in many stocks of over 100% in 2012, it is worth remembering that risk is always present around the corner, often when it is least expected.

This reiterates the focus on the need for research and investors' understanding. We have just completed collating industry figures covering fund and strategy performances not only for 2012, but also for five and ten years since 2008 and 2003 respectively. What the data clearly shows is that over the longer term the average absolute return fund has performed above (5 years) or in line (10 years) with the ASX200 but at a fraction of the market's volatility.

For a copy of AFM's "Volatility eats Returns" report please email us.

Finally, Now for something completely different this week, the 2 Ronnies Name Dropping; or if you find something a bit more risque amusing, try this one.

Regards,

Chris.