Wednesday, January 19, 2005

Hedge funds - the "smart" money is going there

Hedge funds impacts on investors and the markets is growing. New hedge fund inflows amounted to $75 billion in 2004 with arbitrage and event driven strategies receiving the majority of the new money. Hedge funds, numbering about 8000, now manage about $1 Trillion vs. an estimated $8 Trillion in mutual funds. Individual investors and family offices still account for the majority of total hedge fund capital with pension funds holding an estimated 9% of industry assets. Hedge funds have been estimated to account for up to 30% of the daily volume on the NYSE and another estimate suggest at least 75% of hedge funds employ leverage in their process. Hedge funds typically thrive in volatile markets. The VIX index, a measure of the amount of volatility that options traders expect the Standard & Poor's 500-stock index to experience in the near future, recently fell to its lowest level since 1996, dipping below 12. With the equity market volatility being so low, it seems reasonable to conclude that hedge funds were attracted to and hence partially responsible for the large volatility we saw in currency and commodities this year.

The Financial Times reports that the average Morningstar mutual fund return of 8.35% surpassed major hedge fund indicies such as the CSFB /tremendous index , which posted 7.9%. Hedge fund performance has been impacted by lower than usual volatility and returns dispersion in the capital markets and a likely reduction in real capacity as more and more players enter the market. Based on their profitability and allure as an asset gathering tool, hedge funds will no doubt continue their extraordinary growth. However, the inevitable signs of excess are beginning to emerge. Hedge funds are going mainstream Street is buying or building their own capabilities. JP Morgan and Citigroup have joined UBS, Deutche Bank and Morgan Stanley in acquiring or building hedge fund capabilities. Long only hedge funds have emerged. Investors lack of due diligence, very reminiscent of the technology era, was highlighted in a Wall Street Journal last week on Eric Mindich, a new hedge fund manager. His fund ,Eton Street Capital opened with $3 billion, is believed to be the largest launch on record. According to the Journal, Mindich had to turn money away despite a $5 million minimum, a 4.5 year lock up and the fact that he didn't divulge details about his trading strategy and acknowledged he hadn't managed money for several years. If it is difficult to assess manager skill versus luck with relatively full transparency what possible basis will investors have to discriminate between hedge fund managers? Apparently it does'nt matter! We will no doubt be reading about these issues in the months to come.

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