Sunday, February 27, 2005
Multi-Strategy Funds Survey - Barron's Hedge Funds
Monday, February 28, 2005
FUND OF INFORMATION
One-Stop Shopping
More hedging strategies are now accessible to more fund consumers
By LAWRENCE C. STRAUSS
FUNDS OF FUNDS have enjoyed explosive growth in the past few years, with good reason. To buy them, investors don't have to select individual hedge funds, a time-consuming and often difficult process fraught with risk.
Instead, they can invest in a product that has a collection of underlying funds, typically 15 to 25.
Last year, funds of funds had $33.2 billion in net inflows, down sharply from 2003's nearly $60 billion, but still a considerable chunk of change, according to Hedge Fund Research.
An emerging alternative to funds of funds is the multi-strategy hedge fund, a species that appears to be growing in popularity. These funds, which might, for example, focus on convertible arbitrage and distressed investing, attracted a net $14.1 billion last year, up from $5.2 billion in 2003, according to Rye, N.Y.-based TASS Research, which tracks alternative investments, including hedge funds. What's more, HedgeFund.net4 now tracks 180 of these funds, up from 107 a year ago.
"We're seeing more multi-strategy funds because people want the diversification and the one-stop shopping aspect of the structure," observes George A. Kellner, chief executive of Kellner DiLeo Cohen & Co., a New York hedge-fund firm with more than $500 million under management.
Likewise, John M. Kelly, president and chief executive at Man Investments in Chicago, says he's seeing more hedge funds turning into multi-strategy shops, albeit within a "somewhat narrow band" of strategies.
These funds offer several notable advantages over funds of funds, one being fewer fees for investors. A fund of funds has the underlying funds' fees, first of all. And then the fund of funds charges its own fees -- 1% annually for management and a 10% performance fee, for example.
For an investor in a multi-strategy fund, there is only one layer of fees.
In fact, some of the biggest hedge funds these days -- including Citadel Investment Group and Renaissance Technologies -- are multi-strategy shops. (Of course, they almost have to pursue that course, given how much money they run, typically well into the billions.)
Indeed, some other managers have followed suit.
"We're seeing a greater amount of demand on behalf of investors for these multi-strategy funds," explains Neal Berger, president of Apogee Asset Management, a New York multi-strategy shop with about $150 million under management. "The investor is really the customer, and they're driving the supply."
Berger maintains that the multi-strategy setup has considerable advantages over funds of funds, partly because they are able to "monitor traders and positions in real time." He can also keep an eye on investment-style drift that occurs in house.
Tables: Investing Globally5
Slow Start to '056
These multi-strategy funds, he adds, can "act much more seamlessly as far as getting out of one strategy and into another," while "a fund of funds has to deal with redemptions and lockups."
Apogee runs 12 strategies, including its biggest weighting, international statistical arbitrage, which can entail pairing a long position against a short holding in companies around the globe. Other strategies include closed-end fund arbitrage -- buying such a fund at a discount to its net asset value and shorting its components -- arbitraging securities of companies based in India, and even buying environmental credits from companies and then selling them.
It's neither the easiest nor the cheapest fund operation to manage, however. It is, to say the least, labor intensive, considering all the trading talent and back-office operations the firm needs.
"It's almost like running 12 hedge funds under our umbrella," Berger says.
The fund was up 9.6% last year, net of fees, in line with the CSFB/Tremont Hedge Fund Index.
International statistical arbitrage, closed-end arbitrage and two other strategies -- equity volatility arbitrage and capital-structure arbitrage -- account for nearly two-thirds of the portfolio.
"The challenges we face as multi-strategy funds are identifying, attracting and retaining our trading talent," says Berger. "We're only as good as the people we have working here. If people that work for you are really good, they have options -- i.e., starting their own hedge funds."
So far, that hasn't happened to Berger in the two-plus years he's run Apogee, but the industry is rife with tales of traders bolting for potentially more lucrative opportunities running their own hedge funds.
Although multi-strategy funds have gained traction, they are not considered a serious threat to funds of funds.
Kellner asserts that multi-strategy funds "are less diversified than funds of funds and have a generally different client focus -- more sophisticated and less risk averse."
Timothy S. Jackson, a partner at Rocaton Investment Advisors, a Norwalk, Conn., firm that advises institutional investors, allocates capital to single multi-strategy funds and to funds of funds.
"I wouldn't say you need to go one way or another," Jackson says. "For certain investors, a fund of funds might be the only thing that makes sense, because they have a very small staff to monitor the investment."
"We advocate both [styles]," he continues. ""It just depends on the client's objectives."
The downside of a multi-strategy fund, he says, is "more manager- specific risk."
David Basner, managing director, portfolio-management group at TAG Associates, which works with very wealthy investors, says the firm allocates capital both to single- and multi-strategy managers.
One of the advantages of multi-strategy portfolios: "They can shift their capital between strategies a lot faster than we can."
Investing in multi-strategy funds, however, requires checking that these firms are making quality hires in expanding their asset-management talent, Basner adds.
Barry Colvin, president of Tremont Capital Management, which allocates about $9 billion into funds of funds, maintains that multi-strategy funds "have the advantage of one less layer of fees and mobility of capital, although this last advantage is overstated due to various internal agency conflicts."
"You have constituencies that run each of those desks," he says, referring to the various investment styles that hedge funds can deploy.
He adds: "And each of those constituencies doesn't want capital to be pulled away."
In contrast, funds of funds, he says, can allocate "to what they perceive to be the best in class across all strategy disciplines, although lockups and redemption terms may restrict the flexibility of capital to areas of opportunity."
Multi-strategy versus funds of funds is definitely not an either/or situation. Yet it will be interesting to see what kind of assets flows they generate in the coming years.
Not Quite Oscar-Worthy
By most accounts, several published in this column, 2004 was a so-so performance year for hedge-fund returns at best. The CSFB/Tremont Hedge Index posted a 9.6% gain, compared with 10.9% for the Standard & Poor's 500 Index.
Cliff Asness, managing and founding principal of AQR Capital Management in Greenwich, Conn., has another view. With a doctorate in finance from the University of Chicago, Asness brings an academic bent to his views, not to mention a healthy dose of skepticism.
In his most recent quarterly letter to clients, Asness holds forth on several topics, including industrywide hedge-fund performance in 2004.
When compared with cash, in this case Treasury bills, 2004 hedge-fund returns were 1.5 or percentage points above their historical average, as measured from 1994 to 2003, Asness points out. Here's the math: A 9.6% 2004 return for hedge funds minus 1.3 percentage points, or the Treasury bill rate, equals 8.3%. That compares favorably to a historical performance of 6.8 percentage points over cash.
"The only way to measure the skill of an investor, or return to a risk premium, is versus the risk-free alternative," Asness notes. "And on that scale, hedge funds had a pretty good year."
Far from a Pollyanna about hedge funds-a commodity that's not in short supply within the industry -- Asness agrees "with the argument that a lot of new money in hedge funds has lowered the outlook for future returns."
But just not in 2004, in his view.
Asness makes another interesting observation -- this one about how closely long/short equity hedge funds were linked to the overall equity market last year. In previous work, Asness and his colleagues have demonstrated that hedge funds tend to have more beta -- that is, more net long exposure in equities -- when the market has been going up over the last six to 12 months.
Take 2003, a very strong year for equities, with the Standard & Poor's 500 up 28.7%.
Asness took a look at how much exposure long/short funds had to the overall equity market. And he found that in 2004, long/short equity hedge funds, on a monthly basis, had a correlation to the S&P 500 of 0.85%, on average. A correlation of 1.0 would mean these funds had moved in lockstep with the S&P. So at 0.85%, it's pretty close.
And it's considerably higher than the 0.58% average monthly correlation from 1993 to 2002. In other words, a lot of long/short managers had significant long exposure to the broader equity market last year.
To be fair, the art of long/short investing is knowing how to balance the longs against the shorts, and there are certainly times when it makes sense to overweight on the long side, as evidenced by last year's returns.
Indeed, 2004 was a good year for long/short equity managers; the CFSB/Tremont index tracking that category gained 11.6%. "That's the good news," Asness avers. But "it was also a year that dramatically shows that 'hedge' is sometimes a misapplied label."
At the same time, Asness calls this approach "a clearly dangerous strategy that is very exposed to bear markets, and in particular quick bear markets -- a time when many investors might look to their hedge funds for protection." (He points out that a lot of long/short funds, to their credit, reduced their market exposure in 2001 and 2002, thereby saving investor's money.)
He also notes that significant long-only exposure to equities is available elsewhere, notably index funds or actively managed mutual funds -- and those funds don't charge a 1% management fee, along with 20% of profits.
"The point is not to avoid these funds," Asness tells Barron's.
Since 1994, these funds have generated some "positive alpha," meaning they outperformed the market, even with their risk exposure to the market, Asness observes. Investors, he says, should "know what role" these funds play in their overall portfolios.
"Many investors think of these funds as 'hedged,' thus providing diversification versus the market," he says. "But if the crash comes, they may be sorely disappointed."
Smart Moves?
U.S. educational endowments allocated on average about one-third of their portfolios to alternative assets, including hedge funds, in the 2003-2004 fiscal year, a survey shows. That was about in line with 2002 levels, and a big jump from 2000, when the dollar-weighted allocation to those strategies averaged 24%.
Those were among the findings in a recent survey conducted by the Commonfund Institute, which advises endowments on investing and also runs many internal funds of funds for those investors. The survey polled 707 endowments, including Harvard and Yale.
The endowment community was an earlier entrant to the hedge-fund world, in many cases ahead of pension funds.
In terms of alternative strategies, about half the allocations (48%) went into hedge funds, compared with 14% for private-equity funds and 11% for private equity real- estate funds. Smaller endowments tended to invest more heavily in hedge funds than larger endowments -- largely because hedge funds, their lockup periods notwithstanding, are generally more liquid than private-equity or venture-capital funds.
The most popular hedge-fund category among these endowments was multi-strategy, including funds of funds and single-manager funds that invest in several strategies.
John S. Griswold, executive director of the Commonfund Institute in Wilton, Conn., says hedge funds have "been a positive" for endowments, "but there are increasing concerns." Those include excessive expectations for hedge-fund performance. "Fifteen to 20% returns is probably unrealistic," Griswold says. "Return expectations ought to be tempered." And he cautions that endowments, especially smaller ones with fewer investment staffers, will have to pay more attention to assessing the performance and operations of hedge funds in which they've invested.
--------------------------------------------------------------------------------
E-mail comments to editors@barrons.com7
URL for this article:
http://online.barrons.com/article/SB110937735043864784.html
Hyperlinks in this Article:
(1) http://online.barrons.com/page/mlab_scoreboard.html
(2) http://online.barrons.com/page/mlab_fundscope.html
(3) http://online.barrons.com/article/SB110937749015864799.html
(4) http://www.hedgefund.net
(5) http://online.barrons.com/article/SB110938071288764878.html
(6) http://online.barrons.com/article/SB110938071288764878.html
(7) mailto: editors@barrons.com
FUND OF INFORMATION
One-Stop Shopping
More hedging strategies are now accessible to more fund consumers
By LAWRENCE C. STRAUSS
FUNDS OF FUNDS have enjoyed explosive growth in the past few years, with good reason. To buy them, investors don't have to select individual hedge funds, a time-consuming and often difficult process fraught with risk.
Instead, they can invest in a product that has a collection of underlying funds, typically 15 to 25.
Last year, funds of funds had $33.2 billion in net inflows, down sharply from 2003's nearly $60 billion, but still a considerable chunk of change, according to Hedge Fund Research.
An emerging alternative to funds of funds is the multi-strategy hedge fund, a species that appears to be growing in popularity. These funds, which might, for example, focus on convertible arbitrage and distressed investing, attracted a net $14.1 billion last year, up from $5.2 billion in 2003, according to Rye, N.Y.-based TASS Research, which tracks alternative investments, including hedge funds. What's more, HedgeFund.net4 now tracks 180 of these funds, up from 107 a year ago.
"We're seeing more multi-strategy funds because people want the diversification and the one-stop shopping aspect of the structure," observes George A. Kellner, chief executive of Kellner DiLeo Cohen & Co., a New York hedge-fund firm with more than $500 million under management.
Likewise, John M. Kelly, president and chief executive at Man Investments in Chicago, says he's seeing more hedge funds turning into multi-strategy shops, albeit within a "somewhat narrow band" of strategies.
These funds offer several notable advantages over funds of funds, one being fewer fees for investors. A fund of funds has the underlying funds' fees, first of all. And then the fund of funds charges its own fees -- 1% annually for management and a 10% performance fee, for example.
For an investor in a multi-strategy fund, there is only one layer of fees.
In fact, some of the biggest hedge funds these days -- including Citadel Investment Group and Renaissance Technologies -- are multi-strategy shops. (Of course, they almost have to pursue that course, given how much money they run, typically well into the billions.)
Indeed, some other managers have followed suit.
"We're seeing a greater amount of demand on behalf of investors for these multi-strategy funds," explains Neal Berger, president of Apogee Asset Management, a New York multi-strategy shop with about $150 million under management. "The investor is really the customer, and they're driving the supply."
Berger maintains that the multi-strategy setup has considerable advantages over funds of funds, partly because they are able to "monitor traders and positions in real time." He can also keep an eye on investment-style drift that occurs in house.
Tables: Investing Globally5
Slow Start to '056
These multi-strategy funds, he adds, can "act much more seamlessly as far as getting out of one strategy and into another," while "a fund of funds has to deal with redemptions and lockups."
Apogee runs 12 strategies, including its biggest weighting, international statistical arbitrage, which can entail pairing a long position against a short holding in companies around the globe. Other strategies include closed-end fund arbitrage -- buying such a fund at a discount to its net asset value and shorting its components -- arbitraging securities of companies based in India, and even buying environmental credits from companies and then selling them.
It's neither the easiest nor the cheapest fund operation to manage, however. It is, to say the least, labor intensive, considering all the trading talent and back-office operations the firm needs.
"It's almost like running 12 hedge funds under our umbrella," Berger says.
The fund was up 9.6% last year, net of fees, in line with the CSFB/Tremont Hedge Fund Index.
International statistical arbitrage, closed-end arbitrage and two other strategies -- equity volatility arbitrage and capital-structure arbitrage -- account for nearly two-thirds of the portfolio.
"The challenges we face as multi-strategy funds are identifying, attracting and retaining our trading talent," says Berger. "We're only as good as the people we have working here. If people that work for you are really good, they have options -- i.e., starting their own hedge funds."
So far, that hasn't happened to Berger in the two-plus years he's run Apogee, but the industry is rife with tales of traders bolting for potentially more lucrative opportunities running their own hedge funds.
Although multi-strategy funds have gained traction, they are not considered a serious threat to funds of funds.
Kellner asserts that multi-strategy funds "are less diversified than funds of funds and have a generally different client focus -- more sophisticated and less risk averse."
Timothy S. Jackson, a partner at Rocaton Investment Advisors, a Norwalk, Conn., firm that advises institutional investors, allocates capital to single multi-strategy funds and to funds of funds.
"I wouldn't say you need to go one way or another," Jackson says. "For certain investors, a fund of funds might be the only thing that makes sense, because they have a very small staff to monitor the investment."
"We advocate both [styles]," he continues. ""It just depends on the client's objectives."
The downside of a multi-strategy fund, he says, is "more manager- specific risk."
David Basner, managing director, portfolio-management group at TAG Associates, which works with very wealthy investors, says the firm allocates capital both to single- and multi-strategy managers.
One of the advantages of multi-strategy portfolios: "They can shift their capital between strategies a lot faster than we can."
Investing in multi-strategy funds, however, requires checking that these firms are making quality hires in expanding their asset-management talent, Basner adds.
Barry Colvin, president of Tremont Capital Management, which allocates about $9 billion into funds of funds, maintains that multi-strategy funds "have the advantage of one less layer of fees and mobility of capital, although this last advantage is overstated due to various internal agency conflicts."
"You have constituencies that run each of those desks," he says, referring to the various investment styles that hedge funds can deploy.
He adds: "And each of those constituencies doesn't want capital to be pulled away."
In contrast, funds of funds, he says, can allocate "to what they perceive to be the best in class across all strategy disciplines, although lockups and redemption terms may restrict the flexibility of capital to areas of opportunity."
Multi-strategy versus funds of funds is definitely not an either/or situation. Yet it will be interesting to see what kind of assets flows they generate in the coming years.
Not Quite Oscar-Worthy
By most accounts, several published in this column, 2004 was a so-so performance year for hedge-fund returns at best. The CSFB/Tremont Hedge Index posted a 9.6% gain, compared with 10.9% for the Standard & Poor's 500 Index.
Cliff Asness, managing and founding principal of AQR Capital Management in Greenwich, Conn., has another view. With a doctorate in finance from the University of Chicago, Asness brings an academic bent to his views, not to mention a healthy dose of skepticism.
In his most recent quarterly letter to clients, Asness holds forth on several topics, including industrywide hedge-fund performance in 2004.
When compared with cash, in this case Treasury bills, 2004 hedge-fund returns were 1.5 or percentage points above their historical average, as measured from 1994 to 2003, Asness points out. Here's the math: A 9.6% 2004 return for hedge funds minus 1.3 percentage points, or the Treasury bill rate, equals 8.3%. That compares favorably to a historical performance of 6.8 percentage points over cash.
"The only way to measure the skill of an investor, or return to a risk premium, is versus the risk-free alternative," Asness notes. "And on that scale, hedge funds had a pretty good year."
Far from a Pollyanna about hedge funds-a commodity that's not in short supply within the industry -- Asness agrees "with the argument that a lot of new money in hedge funds has lowered the outlook for future returns."
But just not in 2004, in his view.
Asness makes another interesting observation -- this one about how closely long/short equity hedge funds were linked to the overall equity market last year. In previous work, Asness and his colleagues have demonstrated that hedge funds tend to have more beta -- that is, more net long exposure in equities -- when the market has been going up over the last six to 12 months.
Take 2003, a very strong year for equities, with the Standard & Poor's 500 up 28.7%.
Asness took a look at how much exposure long/short funds had to the overall equity market. And he found that in 2004, long/short equity hedge funds, on a monthly basis, had a correlation to the S&P 500 of 0.85%, on average. A correlation of 1.0 would mean these funds had moved in lockstep with the S&P. So at 0.85%, it's pretty close.
And it's considerably higher than the 0.58% average monthly correlation from 1993 to 2002. In other words, a lot of long/short managers had significant long exposure to the broader equity market last year.
To be fair, the art of long/short investing is knowing how to balance the longs against the shorts, and there are certainly times when it makes sense to overweight on the long side, as evidenced by last year's returns.
Indeed, 2004 was a good year for long/short equity managers; the CFSB/Tremont index tracking that category gained 11.6%. "That's the good news," Asness avers. But "it was also a year that dramatically shows that 'hedge' is sometimes a misapplied label."
At the same time, Asness calls this approach "a clearly dangerous strategy that is very exposed to bear markets, and in particular quick bear markets -- a time when many investors might look to their hedge funds for protection." (He points out that a lot of long/short funds, to their credit, reduced their market exposure in 2001 and 2002, thereby saving investor's money.)
He also notes that significant long-only exposure to equities is available elsewhere, notably index funds or actively managed mutual funds -- and those funds don't charge a 1% management fee, along with 20% of profits.
"The point is not to avoid these funds," Asness tells Barron's.
Since 1994, these funds have generated some "positive alpha," meaning they outperformed the market, even with their risk exposure to the market, Asness observes. Investors, he says, should "know what role" these funds play in their overall portfolios.
"Many investors think of these funds as 'hedged,' thus providing diversification versus the market," he says. "But if the crash comes, they may be sorely disappointed."
Smart Moves?
U.S. educational endowments allocated on average about one-third of their portfolios to alternative assets, including hedge funds, in the 2003-2004 fiscal year, a survey shows. That was about in line with 2002 levels, and a big jump from 2000, when the dollar-weighted allocation to those strategies averaged 24%.
Those were among the findings in a recent survey conducted by the Commonfund Institute, which advises endowments on investing and also runs many internal funds of funds for those investors. The survey polled 707 endowments, including Harvard and Yale.
The endowment community was an earlier entrant to the hedge-fund world, in many cases ahead of pension funds.
In terms of alternative strategies, about half the allocations (48%) went into hedge funds, compared with 14% for private-equity funds and 11% for private equity real- estate funds. Smaller endowments tended to invest more heavily in hedge funds than larger endowments -- largely because hedge funds, their lockup periods notwithstanding, are generally more liquid than private-equity or venture-capital funds.
The most popular hedge-fund category among these endowments was multi-strategy, including funds of funds and single-manager funds that invest in several strategies.
John S. Griswold, executive director of the Commonfund Institute in Wilton, Conn., says hedge funds have "been a positive" for endowments, "but there are increasing concerns." Those include excessive expectations for hedge-fund performance. "Fifteen to 20% returns is probably unrealistic," Griswold says. "Return expectations ought to be tempered." And he cautions that endowments, especially smaller ones with fewer investment staffers, will have to pay more attention to assessing the performance and operations of hedge funds in which they've invested.
--------------------------------------------------------------------------------
E-mail comments to editors@barrons.com7
URL for this article:
http://online.barrons.com/article/SB110937735043864784.html
Hyperlinks in this Article:
(1) http://online.barrons.com/page/mlab_scoreboard.html
(2) http://online.barrons.com/page/mlab_fundscope.html
(3) http://online.barrons.com/article/SB110937749015864799.html
(4) http://www.hedgefund.net
(5) http://online.barrons.com/article/SB110938071288764878.html
(6) http://online.barrons.com/article/SB110938071288764878.html
(7) mailto: editors@barrons.com
# posted by Tom @ 3:47 PM 
