Fund of hedge funds grabs early dollars

Australian investors are warming to hedge funds. Current figures show they have invested slightly more than $5 billion into hedge fund strategies, $300 million of which has flowed into fund of funds and single strategy managers from Australian superannuation funds.

Colonial First State (CFS) head of hedge funds and Alternative Investment Management Association (AIMA) chairman Damien Hatfield is the man holding the numbers revealing the size of the domestic hedge fund market. A breakdown of the $5 billion reveals $3 billion sitting in fund of funds with the balance invested in single-style strategies.

According to Hatfield, the largest player in the fund of funds market is the OM Strategies Fund (which originates from the old Ord Minnett group but is now a separate company) with $2 billion. Deutsche has about $150 million and CFS is not too far behind with $80 million. Rothschild and Hedge Funds of Australia (HFA) are also major players in the Australian market, with HFA expecting more than $100 million by September, predominately from direct retail and master trust investments.

The largest to date of the single strategy funds is the billion dollar Grinham Managed Fund, with 90 to 95 per cent of its investments originating offshore. PM Capital has about $300 million in assets and Optimal Fund Management, which runs a Long Short Japanese Equity Fund, has $250 million.

The Australian hedge fund market has also been investigated by InvestorWeb Research, which released its Hedge Fund Sector Report in June this year. The report looked at the overall growth of the hedge funds sector, and revealed an estimated US$500 billion of funds under management in the global market sitting in more than 7,000 funds.

The report also analysed nine Australian hedge fund managers and 26 hedge fund products. Supporting Hatfield’s figures, the report also revealed the fund of funds style is proving to be the most popular while the hedge fund market remains in its infancy.

“Initially, fund of funds has been the preferred route of managers and been the initial entry point for clients and advisers alike,” InvestorWeb Research senior investment manager David Smythe says.

He says the popularity of the fund of funds style to date is also due to a number of other reasons, including diversification and the specialist skills set required by single strategy managers.

“Because hedge funds are a new entrant, advisers are more comfortable in a lower risk product. Also, mainstream managers who do not have in-house capabilities will either set up relationships with international managers, for example Rothschild with Grosvenor, or will go with the fund of funds,” Smythe says.

“It will take a period of education before they feel comfortable with a single sector approach.”

While the Australian hedge fund market is comparatively much smaller, as revealed by Hatfield’s figures, it is also growing as support for alternative investing increases with both institutional and retail investors looking for added outperformance.

“The international comparison gives an idea of growth potential,” Smythe says.

Specialist manager HFA, which has 13 products built from four core offerings, is also experiencing demand for fund of funds products. Three of the four core products are fund of funds offerings with the fourth a single strategy. Similarly, the ratio of invested funds is three to one in favour of fund of funds.

“The split of funds under management at HFA has typically been approximately 25 per cent single strategy and 75 per cent fund of funds,” HFA managing director Spencer Young says.

“Fund of funds offer greater diversification and greater security of return than single strategies and in this market environment that is a highly sought after feature.”

While fund of funds is currently the most popular style, Hatfield believes the next stage of the local hedge fund market should see single strategy funds grow in popularity, in particular long/short equity, which currently accounts for 42 per cent of international asset flows.

“Traditional investors will look at equities, value or growth and then consider long/short equity. Although there aren’t many managers of long/short equity style, some are starting to develop solid track records, for example K2 Asset Management, Eclectic Capital Management and Vertex,” Hatfield says.

“As time goes by we will start to see more traditional investment dollars flow into these funds.”

Hatfield says other specialist areas should also increase in popularity, such as event driven and fixed income arbitrage. He says these are more complex strategies and investors have greater difficulty understanding the activities, however, their popularity should increase in the next 18 months to two years as investors become more educated and get a handle on the different strategies.

And while the future of the hedge fund market in Australia looks set to continue its climb, just how steep the ascent will be is unknown at this stage. International hedge fund assets are growing at more than 20 per cent a year, but that growth may not be reflected in the Australian market.

“There is a lot of hype and there will be strong growth, but how much will depend on how well we educate and promote hedge funds to investors,” Hatfield says.