Hedge Funds Continue To Boom Away In The US

Mike Godfrey, Tax-News.com, New York

23 February 2001

Figures from the hedge fund sector continue to reflect its popularity among investors and its relative success in investment terms, but a prestigious US research firm has produced a statistical analysis which casts doubt on the extent to which the skills of hedge fund managers are responsible for their success.

The CSFB/Tremont Hedge Fund Index, one of the sector's most watched indicators, rose by 4.8% during the year 2000, taking in a net $8bn in assets, while in December alone the Index rose 2.7%. Hedge funds took in a net $2.7bn during the last quarter of 2000.

Figures from Tass Research, the information and research unit of Tremont Advisers, show that long/short equity funds (which were highly publicised late in 2000) attracted $1.75bn in the fourth quarter, making it the most popular asset class, and $12.4bn for the year. Long/short startegies combine being 'long' in securities that seem undervalued, but 'short' in those that seem over-valued. You still have to know which is which, of course. Event-driven and arbitrage funds did second and third best, while equity-market neutral didn't do so well in the final quarter despite having a good year overall.

Nicola Meaden, chief executive of Tremont Tass (Europe), said: "For the first time in many years, investors were very serious about selecting strategies with limited net market exposure and low correlation to the overall markets."

Meanwhile, a study published this week by three principals of AQR Capital Management claims that most statistics on hedge funds are distorted because they contain illiquid securities. The three authors, Clifford Asness, AQR's managing principal, Robert Krail and John Liew ran substantial money funds for Goldman Sachs before leaving to start AQR, where they currently manage about $750m. Last year their funds returned 19% and 29% before fees. They say they seldom invest in illiquid securities and that their returns are very de-coupled from the market.

The study is based on hedge-fund data from the CSFB/Tremont database which AQR analysed on several different bases. The first basis, using unadjusted values for illiquid securities (ie their value when last traded) showed that two thirds of the superior returns claimed by hedge funds could be due to their managers' skills - but when they adjusted the prices of illiquid securities to match market conditions, the 'skill factor' seemed responsible for only 16% of hedge funds' good performance.

The study has caused some discontent in the industry. "Methodologically I think they started with a conclusion and worked backwards to achieve it; it has that feeling to it," says Ezra Mager, a general partner at the Torrey Funds, which helps investors create hedge-fund portfolios, quoted in the Wall Street Journal.

It makes some sort of sense that illiquid stocks would over-rate valuations when markets are falling - but then they should have the opposite effect when markets rise. Therefore the long-term results of hedge funds should be fairly independent of the behaviour of illiquid stocks.

As is well known, you can prove anything with statistics, especially if you are trying to prove you're cleverer than other people. But there is more and more evidence that far from being the risky temptations of the devil that regulators would have us believe, hedge funds taken en masse are if anything more stable and less risky than 'conventional' investment instruments.

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