Okay, I guess I was wrong.
Just after the market meltdown, around spring and summer of last year, I really thought that investors across the board were going to shirk back in a big way and for a long time.
I used the same tired line many times: After the Depression, it took 25 years for the markets to hit those pre-crash levels again. Sometimes, if I were really in Guru mood, I would pontificate on the “defining moment of a generation of investors.”
But this time around, after our stock crash and subsequent “great recession,” it only took a matter of weeks for that kind of comeback.
Still, I was not deterred. Too soon, I retorted. The markets must be wrong (and, by implication, I was right). But now, I’m getting pushed back yet another step: Hedge funds, one of the ultimate signs of investor confidence, may be staging a comeback.
After getting the stuffing knocked out of them over the past couple of years, there is growing confidence in this investment vehicle. That, at least, is the conclusion from a study by Rothstein Kass called “2010 Hedge Fund Outlook: Back to the Future?”
It said that the industry is steadily recovering from the credit crisis, and that more than 82% of respondents expected more fund launches this year than in 2009.
To be sure, the majority of those surveyed (70%) expect 2010 to be a difficult year, but one of improvement.
Indeed, one recent launch came from Oakley Alternative Investment Management. Earlier this month, it launched Oakley Opportunities Fund, its second fund-of-funds, to complement its Oakley Absolute Return Fund. Nick Hannan, chief investment officer, said that the second fund was launched because of client interest seeking higher returns from a “thematic strategy.” It plans to invest mostly in small mutual funds, and right now it sees opportunities in bearish macro funds, he says. It also likes emerging markets funds and currencies, he says.
While its existing clients are interested in these investments, he says the broader public still has a negative view of this industry because of all the turmoil in 2008 and 2009. But this is a different industry today, he says, with more transparency and more regulation.
Morningstar’s alternative investment analyst Nadia Papagiannis said hedge funds in general are not taking on the same amount of leverage as they did a few years ago. And she agrees that there is more “exposure transparency.” That is, investors can at least know what percentage of the money is being put into this or that type of asset class. Institutions used to just give hedge funds hundreds of millions of dollars without any real knowledge as to how the money was being invested, she says. But now, they’re just not as free with the cash.
Even if there is interest in hedge funds again, the returns aren’t quite there yet. According to the Credit/Suisse Tremont Hedge Fund Index, the year-to-date gain is 1.48%. The Barclay Hedge Fund Index shows a gain of .10%. The S&P 500 has lost .04%.
So, what to do?
The heightened transparency is certainly good. Except for the odd bond rally now and then, the markets have pretty much been moving sideways for a while so investors are scrounging for new ideas. But if clients are asking about hedge funds, you need to be having detailed conversations with them so they really know what they’re getting into.
They need to understand risk-adjusted return. At the very least, they need to know there really is no such thing as “absolute return.” To be sure, not all hedge funds market themselves on that idea. But for those that do, Papagiannis suggests that investors should know what type of market, hypothetically, is not conducive for that particular fund. If the fund is a convertible arb fund, for example, and there just aren’t than many such deals out there at the moment, its absolute return begins to look pretty relative.
Risk appetite and hedge funds may be back much sooner than some of us ever expected. And advisors need to be on the ball when talking to clients about these investments.