Hedge funds wait for investors

Despite a flurry of activity hedge funds appear to have gone off the boil. John Wilkinson takes a look at what slowed down this sector and when it will rebound.

On the surface there appears to be very little happening with hedge funds in Australia. Last year there were promises from fund managers that a raft of funds would be launched and that this it was going to be the next big asset class.

Rothschild associate director of alternative investments Richard Keary however emphasizes that it is still early days for hedge funds in Australia.

"The Alternative Investment Management Association formed an Australian chapter last month and attracted about 40 members instantly. There are a lot of things happening below the surface at present," he says.

Money Management understands that Colonial First State is putting together a team to create some hedge fund products and it is expected that AMP will source some funds from its international partner Henderson.

Keary says Rothschild is looking to create a global fund of funds managed by Grosvenor Capital although there is no timescale as to when this could be introduced into Australia.

AM has outsourced its hedge fund to Absolute Capital, a boutique manager run by its former staff member Deon Joubert. At the same time Challenger has put the launch of its hedge fund on hold according to alternative investments senior manager James Chirnside.

"We started to develop a fund of funds hedge fund but found the depth of managers here was not good enough. Then we looked at offshore managers but the tax implications put this out of the ballpark," Chirnside says.

Challenger is now developing a pilot hedge fund project in-house using internal managers.

"We aim to build up a track record and test the systems before launching any product," Chirnside says.

Joubert says one of the reasons for the delay in the rollout of hedge funds is that fund managers in this sector are building the people-skills and systems.

"Suddenly, a lot of fund managers have been hiring staff and setting up departments. Also the superannuation funds are sending asset consultants to look at hedge funds as the trustees prepare to make investment decisions," Joubert says.

Keary says there is a lot of interest from retail investors, although they are frustrated by the lack of funds available in that sector. The other problem is that investors are being confronted with an unfamiliar number of brand names as hedge funds might be sold under their overseas manager's name more prominently in the future.

Keary says the lack of ratings and surveys for the sector is also a handicap at present, although these will become more common as products build a track record.

Joubert says another problem is that investors see hedge funds as high-risk, whereas they can act as conservative investment products as well.

He cites the example of an equities fund that can be constructed as a conservative investment vehicle that will return a consistent return despite what the market is doing.

"The fund will make a positive return regardless which way the market is heading," he says.

Joubert gives an example where the equities sector suffered a negative return of four per cent for March, but the hedge fund his company manages for AM gave a 0.8 per cent return.

Keary agrees hedge funds do not have to be high-risk investment products, especially if only a small part of a portfolio is given to this sector.

He cites the leverage buy-out fund run by T H Lee in the US, which has a compound return of 65 per cent. This is tempered by good and bad individual year returns, therefore is high-risk.

Keary argues that by putting one per cent of a portfolio into this fund, the investor is only exposing that percentage of investment to that high risk.

"It depends of what suits the investor. A long-term investor would put 80 per cent of their assets into long-term investments and then allocate some of the remaining 20 per cent to hedge funds," he says.

Joubert says the key to investing in hedge funds is preparing an investment strategy.

"It is important you find the right manager to suit your investment strategy. However, it is important you design your strategies first," he says.

Joubert's new operation is producing hedge fund investment strategies for investors as it has the ability to analyse the managers in more detail than the average investor.

The education process of the investor will help improve this understanding of a manager's investment process. All managers active in the area agree investors are understanding the role of hedge funds better, although Joubert says further work still needs to be done.

This is a role that will probably have to be undertaken by the fund managers if they want investors to seriously look at their products. But where will hedge funds be in 12 months?

Chirnside believes the proposed rate of take-up for the sector is still some way off yet.

"The drivers of this growth will be the education process and suitable investment vehicles. The lack of managers in Australia will limit growth and the limited capacity of products will control the amount of money people put into the sector," Chirnside says.

Keary says a lot of the interest in hedge funds has not been matched by inflows.

He estimates about $500 million has been invested in hedge funds in Australia, but believes there is still a lot of potential.

"If investors put 10 per cent of a portfolio in hedge funds, and the Australian funds management industry is worth $500 billion, that means there is $5 billion of potential investment," he says.

One restriction Keary believes will limit growth is the liquidity of hedge funds.

"When a hedge fund can have a unit trust structure, with daily unit prices and redemptions, then the growth will happen," he says.

Another challenge for the sector will be the ability of local managers to develop products.

Joubert believes hedge funds will be experience another 12 months of the status quo, consisting of mainly wholesale funds, with a few retail offerings as managers build their products and teams.

But Keary says after this time the strength of the product development teams and the global ability to research international hedge fund managers will become increasingly important.

"That will be hard for an Australian manager with a couple of people in the product development team to actively compete when the standards are lifted," he says.