We recently reviewed an article in The Economist which provided an excellent summary of the challenges of establishing a hedge fund in the current environment, even if the article's title, "Launch Bad" left a little to desired, assuming it wasn't a simple typo. Actually the first sentence was somewhat off the mark also, claiming that when starting a hedge fund "bar inheritance or winning the lottery, there are few swifter paths to immense riches".

However, back to the excellent article which (excluding the title and the first sentence) does paint an accurate picture of the challenges facing not only any aspiring fund manager, but the vast majority of the existing funds as well.

Although the Economist's focus was naturally on the challenges in the US and Europe there are many parallels in Australia for aspiring managers, with increased due diligence, a focus on fees, and regulations all featuring to a greater or lesser degree.  What is interesting to us is that there have been a number of start up funds in the past 12-18 months, with the trend being towards better levels of strategic thought, business process, and risk management than in the past.

As a result the investors who back early stage managers continue to do so partly because research shows that while not without some risks, early stage, smaller or boutique fund managers provide significantly better returns, better transparency and more personal investor relations. Read the balance of our review here.

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

Magellan Global Fund was up 1.92% in March 2013 taking its 12 month performance to 19.78% as compared to an index (MSCI World Net) return of 11.1%. All stocks in the portfolio produced positive local currency returns and the portfolio was fully invested.

Auscap Long Short Australian Equities Fund had a strong return of 1.46% over March with an average next exposure of 116.5%. Performance benefited from exposure to property trusts, healthcare and materials sectors and avoiding the mining sector

Allard Investment Fund fell 2.1% over March impacted by the $A and generally weaker Asian markets. Twelve month performance was 6.72% and since inception performance 8.47% net compound annual return. Notable is the Funds low volatility at around two-thirds of the MSCI Asia Pacific ex Japan Index.

Monash Absolute Investment Fund returned a solid 2% over March bringing its six month return to 17.17%, achieved with an average net exposure of 62%. The portfolio avoided defensives, Telstra, consumer staples and utilities.

Continuing our successful Meet the Manager presentation series on Thursday 16 May, AFM is holding a city lunch time briefing featuring Jack Lowenstein from Morphic Asset Management. Contact us to reserve your seat.

As a tribute to yesterdays ANZAC Day, we would like to show this short clip of The Last Post from the Sydney Symphony.

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

Regards,

Chris
CEO, AUSTRALIAN FUND MONITORS

A recent article in The Economist provided an excellent overview of the challenges of establishing a hedge fund in the current environment, even if the article's title, "Launch Bad" left a little to desired, assuming it wasn't a simple typo. Actually the first sentence was somewhat off the mark also, claiming that "bar inheritance or winning the lottery, there are few swifter paths to immense riches".

It is estimated that there are over 20,000 absolute such funds globally, variously described as absolute return, alternative or hedge funds. There are no doubt some which have made their founders immensely wealthy, but in spite of their profile they are a significant minority, and almost none have done it swiftly. The Economist should know better.

However, back to the excellent article (excluding the title and the first sentence) which does paint an accurate picture of the challenges facing not only any aspiring fund manager, but the vast majority of the existing funds as well.

The article focuses on the increased level of due diligence and compliance which institutional investors in particular focus on, an area that is frequently difficult for new and emerging managers to tick the appropriate boxes. Bernie Madoff of course made things more difficult in this regard, but with the increased institutional investment, plus the risk averse post GFC world,  this was always going to be the trend.

Along with due diligence from prospective investors the current crop of new managers also face increasing regulatory hurdles, particularly in the USA and UK/Europe. Australia's regulations have remained reasonably constant and consistent, (short selling bans aside) but that may be because they were better to start with.

Fees remain under pressure, but that is probably consistent with margins in most other industries, and particularly in financial services. In addition, any industry that emerges into the mainstream is always going to face competitive pricing pressure.

The initial capital raising process is certainly more difficult than it was seven or eight years ago. Back then the big investment banks would toss anywhere from $50 to $500 million to a star trading team wanting to leave the desk and set up on their own, just to ensure they could feed on the fees from prime brokerage operations including leverage, brokerage and stock lending.

Now many start ups have little other than choice of the three F's (friends, family and fools) or a couple of seed investors with which to build the three year track record that most institutions, asset allocators and research houses demand. Umbrella groups or incubators in Australia such as Bennelong, Ascalon and Pengana generally prefer a decent track record prior to risking their capital and reputation by investing in an early stage or start up manager.

There are exceptions, mainly those former star portfolio manager with a prior high profile who gain the backing of an institution or distribution house, but they are certainly in the minority.  All this leads to the question, why bother?

For some it's the opportunity, some a necessity as the big banks close their proprietary trading desks as a result of the Volker Rule in the US. For others, the challenge, or wish to prove their own worth after ten or twenty years under the perceived security of a broad corporate roof.

But what of the investors who back them and take the risk of allocating to early stage manager? Reduced fees certainly don't make the difference, but all the research shows that early stage, smaller or boutique fund managers provide significantly better returns, better transparency and more personal investor relations.

It is open to debate if this improved performance is due to the alignment of interests, managing smaller pools of capital, or lower levels of bureaucracy, but it hasn't changed much over the past decade.   

So much so that the big end of town is trending back to funding start ups, but with the added incentive of sharing the revenue when they're successful.  As in the past however, and in spite of the impression given by The Economist, only a handful make it to the front pages, and almost all will take a decade at least to confirm their position. 

Hardly swift or overnight success, and only if they provide their investors their promised, or hoped for, returns.

Chris Gosselin
CEO, Australian Fund Monitors

In 2012, AFM hosted a series of lunch presentations  entitled "Understanding Hedge Funds" which provided investors with a more balanced view on the sector than is sometimes portrayed in the media.  Following feedback from a number of our guests we also organised briefings and presentations for a small group of investors to "meet the manager" and hear from individual fund managers in person.

Our "Meet the Manager" briefings will be held every month, over breakfast or lunch and will showcase AFM's Fund Manager clients, their available Funds and views of the current market and opportunities ahead.  

If you are interested in attending any of AFM's "Meet the Manager" briefings, please reply by email.

Fund Managers wishing to participate in the presentation series are invited to contact Chris Gosselin, CEO, to discuss the opportunity.