Dysfunctional Markets sorting the hedge fund wheat from the chaff.

The dysfunctional markets of 2011 (or should that be four years?) are making it difficult to provide investors with absolute returns. However over 50% of Australian Hedge Funds have provided a positive return over the past 12 months, demonstrating that investors should be increasing their allocation to hedge funds in 2012 - provided they invested in the right 50%. 

Meanwhile only 10% of the 270 funds in AFM's database have under perfomed the fall in the ASX200 of 10.13% over the 12 months to the end of November. Depending on how far down the list they sit, the other 50% of managers might see redemption notices rather than greeting cards in the mail this year.

With the ASX200 racking up its seventh losing month this year, and only one positive month in the last eight, the market's direction has frequently seemed as random as the toss of a coin. It is a true test of investment and risk skills to produce a positive return when the market has fallen over 13% year to date.

On that note we are pleased to see that AFM's Model Portfolio of five Australian equity funds returned +1.90% for November for a 12 month return of 18.47%, certainly vindicating their inclusion in the best of breed category.  Annualised returns from this portfolio over the past five years now stand at 16.84% with a volatility of just 5.76%

However, if there's one thing these markets are doing, it's sorting the wheat from the chaff when it comes to manager selection.  From that perspective we expect that 2011 will be a pivotal year for the industry in Australia and overseas.  Managers who have proven they can provide positive returns - particulary those who have consistently done so - across all market conditions should find themselves in high demand.

Given the typically boutique structure of the industry, and the general reluctance of the larger superannuation funds to allocate to local absolute return managers, it will be the Self Managed (SMSF) sector and Family Offices which are most likely to benefit. 

On a different note it was pleasing to see the announcement by the Australian Government confirming that foreign based funds investing in Australian managers would no longer be subject to tax on profits from capital gains.  This has the potential to significantly lift the interest of offshore investors, and inflows into local managers.

For details on all funds in AFM's database see www.fundmonitors.com.  Meanwhile we wish all our members and subscribers a happy and healthy festive season, and best wishes for a healthy, happy and prosperous New Year.

Regards,

Chris Gosselin

Astarra's Shawn Richard pleaded guilty to two charges of dishonest conduct in the course of carrying on a financial services business and admitted a third charge of making false statements in relation to financial products.

According to ASIC's website, Richard, 35, appeared at Sydney's Downing Centre Local Court on 7th December to face allegations that he dishonestly received undisclosed payments in his role as investment manager of the Astarra Stategic Fund (ASF) and Astarra Superannuation Plan (ASP) and that he knowingly made materially misleading statements about the value of investments made by the ASF.

ASIC alleged, among other things, that Mr Richard was involved in causing the ASF and ASP to place investor monies in overseas hedge funds, in circumstances where Mr Richard would personally receive a significant portion of the monies for his own benefit and for the benefit of his company, AAM. The monies Richard placed in the overseas hedge funds had been raised by the responsible entity of ASF, Trio Capital Limited (Trio). ASIC alleged that Richard and AAM received in excess of $6.4 million in undisclosed payments.

ASIC also alleged that Mr Richard made materially misleading statements about the value of the ASF's investments in the overseas hedge funds, knowing that these statements were included in valuation statements provided to Trio and were likely to have the effect of inducing Trio to seek further investments in the hedge funds.

The charges each carry a maximum penalty of 5 years' imprisonment or a $220,000 fine, or both when Richard returns for sentencing on 4th February 2011.

The nature of a market generally ensures there's a wide range of opinions from managers, but in September there were some consistent themes amongst managers' performance commentaries.

Overall average performance for the month was strong on the back of the strong rally in equity markets, particularly in the US, a weak US currency, and strong commodity markets.

In Australia the strong performance of many second tier resource stocks was a welcome reward for managers focusing on that sector, particularly as the US dollar weakened and gold rose. However a couple of interesting comments emerged, such as Optimal's George Colman, who noted that of the ASX200's rise of just over 4% for the month, three quarters of it could be attributed to the market's sharp rally in the first four days of the month.

Looking forward the most recurrent comment, and in many cases concern, pointed to the highly anticipated QE2, or quantitative easing in the US. While most commented that given the US' lacklustre economy something needs to be done, the concern lies in what happens next in the event that a further easing doesn't kick-start the economy, and the inflationary pressures that printing more money is going to have. Kapstream's comment in particular was both insightful and creative, likening the anticipated QE2 to the Cunard liner of the same name which having once ruled the waves in many roles, now sits in Dubai waiting....

Most managers still seem to consider the markets to be finely balanced, and there aren't too many rampant bulls, with many keeping their powder dry until more convinced that the rally can push on through resistance without being derailed by some macro issues from offshore..

The debate over how Super Funds report returns - net of fees or gross - is once again generating debate amongst the financial services industry, but isn't the answer pretty obvious?

For some sections of the industry to prefer to report gross returns seems illogical - or at least self serving.  The hedge fund and absolute return sector, long criticised for having high fees, generally reports returns on a net basis and has always been transparent, (with few exceptions) on both the level and structure of fees.  There seems no reason for the superannuation sector not to do the same.

AFM has long held the view that the debate over the size of a fund manager's fees is to some degree academic.  Surely what is vital is the actual return received by the investor once all fees, charges, costs and commissions are taken into account.  Funds should be avoided if the fee structure does not align the manager's interests with those of their investors, and managers should be held to account if fund performance fails to match their stated objectives.

So we would agree with David Whiteley, chief executive of the Industry Super Network, and others in their argument that fees should be transparent and returns reported on a net basis.

Once that's achieved it is hoped that investors (both institutional and retail) will focus more on returns, preferably on a risk adjusted basis, and other key performance criteria, to allow informed debate, choice and decisions.

With the ASX200 rallying over 5% in September, and the S&P over 8%, initial results based on 20% of results to date have seen some strong results.  Average results from all funds received to date are up 2.88%, with equity based funds up 3.08% reflecting the equity rally.

Strongest performances to date include Commodity Strategies Long/Short (+11.05%) and Long Only (+7.53%), Matthews Global Macro Velocity Fund (+10.76%), K2's International (+8.39%) and Asian (+7.61%), and Pengana's Global Resources Fund (+7.93%).

No currency funds have reported as yet, and with the surging A$ it will be interesting to see results from the FX funds as the month progresses.