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Hedging Our Bets
John Ferry
11/01/2004
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For those without the investable assets necessary for direct hedge fund
investment, funds of funds offer many traditional hedge fund benefits with lower
investor capital requirements. Using pooled assets, these funds invest in a
number of hedge funds on behalf of investors. They offer diversification, and
perform the same thorough due diligence that wealth advisors perform for direct
investors. As such, funds of funds reduce both idiosyncratic hedge fund risk,
and the traditional time burdens associated with fund maintenance. Likewise,
hedge fund index investments, such as those linked to the CSFB/Tremont index,
offer similar benefits.
There are, however, downsides to these investment
vehicles. Hedge funds charge relatively high fees—typically a 1 or 2 percent
annual management fee plus up to 20 percent of any upside generated. A fund of
funds client pays these fees plus another similar set of fees to the fund of
funds manager.
Hedge fund managers employing established investment styles to take advantage of
market volatility and inefficiencies are finding that in the competitive world
of hedge funds, popular strategies have limited shelf lives. “We’ve had to go
outside the United States to find additional strategies, because there really
aren’t a lot of inefficiencies left in these markets, or in the markets that
U.S.-based investors target,” says Harry Krensky, managing partner and founder
of South Norwalk, Conn.-based Discovery Capital Management.
The problem,
Krensky explains, is the proliferation of new hedge funds chasing a limited
number of opportunities. “Whether it’s risk arbitrage, convertibles or fixed
income, there has been so much capital going into these areas that opportunities
are much lower than they were,” Krensky says.
According to Joelle Weiss,
president of CBG Investment Advisors in New York, the dearth of opportunities is
forcing managers to come up with new strategies in which hedge funds would not
normally engage, such as lending directly to businesses. “I’m finding a lot of
managers going into the private lending market space, which is not good, because
it’s not liquid,” she says. “They’re moving away from the public market and
lending to companies that have no other place to borrow, so it’s kind of like
distressed debt.” The idea, Weiss says, is that the hedge fund does its own
fundamental credit research and identifies a company that it thinks the market
has misjudged as about to go bust, when in fact there is a good chance that it
will turn around with a little backing. The hedge fund then gives the business a
direct loan and charges a relatively high rate. Says Weiss, “It tells you that
the public markets are not offering anything attractive at the moment.”
Additional Information
 Hedge Fund Investment Styles
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