Investment Insights

Jeff Benjamin

Coming soon: 'Return of the Hedge Fund'

Since investment returns have improved, expect clients to come knocking at your door

Dec 6, 2009 @ 12:01 am

By Jeff Benjamin

Hedge fund performance is cooking again, which means that advisers should brace for a new onslaught of investor inquiries about alternative strategies.

That prediction is based on several observations, chief among them that wealthy investors — contrary to the assumptions of regulators and some product providers — are just as prone to irrational performance-chasing as regular folks.

That point was driven home last year when the hedge fund industry had one of its worst years ever.

After the carnage was reckoned, most hedge fund indexes reported yearly declines of more than 18%. Net outflows for the year were more than $64 billion — almost 38 times greater than the $1.7 billion the industry lost in 2000, the last time it had full-year net outflows.

Some of the rush to the exits may have been a result of Bernard Madoff and what Charles Gradante, a managing principal at the hedge fund advisory firm Hennessee Group LLC, calls “fear of another fraud.”

Now, with hedge funds on track to show their best annual performance in a decade, we're likely to see investors pounding on the doors, fearful that they will miss gains.

Depending on the database and index, hedge funds already gained close to 20% this year through the end of October. November tallies should start coming out this week, and the expectations are high for a full-year return that surpasses the 19% gain in 2003, making 2009 the best year since the 31% gain in 1999, according to Hedge Fund Research Inc.

While this year's performance is essentially in line with the S&P 500's, the hedge fund industry has not been shy about pointing out that its 2008 decline was less than half of the S&P's 38% loss.

The latest performance numbers, coupled with 2008's relative performance, gives hedge fund proponents a strong case in their argument that hedge funds are worth the expense, effort and risks.

For advisers whose clients decide to invest in hedge funds next year, the key issue will be how best to direct the flows.

Help in that area can come from firms such as Altegris Investment Inc., which offers access to pre-screened hedge funds. Like wirehouses that screen hedge funds and act as gatekeepers for their brokers, the Altegris platform gives independent advisers access to feeder funds that pool investments to create a single limited-partner hedge fund investor.

The feeder pools set investment minimums at between $10,000 and $100,000, and give investors access to such notable hedge fund shops as Paulson & Co. Inc., Brevan Howard Asset Management LLP and Winton Capital Management Ltd.

Altegris president and chief executive Jon Sundt said his company does the due diligence and background checks “and all the other stuff” that advisers are supposed to do before investing in a hedge fund. What firms such as Altegris offer — for asset-based fees ranging from 75 to 150 basis points — is a kind of well-policed on-ramp.

The funds themselves should welcome this assistance, because advisers certainly do. Morgan White, a managing director at Osborne Partners Capital Management LLC likes the fact that firms such as Altegris do the necessary due diligence and have access to hedge funds Osborne can't get on its own. The fees don't seem to be a problem.

Whether or not an adviser opts to outsource hedge fund research and due diligence, though, the most satisfied hedge fund investors appear to be those who have been well-matched to strategies based on correlation, diversification and risk — not just performance.

That's a good point to remember now that performance is once again heating up.

Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com.

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