30/08/2005 - 22:00

Tim Treadgold: Briefcase -Bets hedged on value of these funds

30/08/2005 - 22:00

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If you are being tempted to play the new investment game sweeping Australia and dabble in a hedge fund investment, think again. The latest data from overseas shows that hedge funds are doomed because they’ve become too risky and, above all, they’re not performing.

A few years ago hedge funds, which are little more than pools of investors’ money leveraged many times with bank debt, were all the rage.

Early movers in the overseas rush boasted of super returns earned from hedge funds which played the metal, oil and government-bond markets. While traditional investments were yielding 5 per cent to 10 per cent, hedge fund managers were claiming 30 to 40 per cent, and peeling off outrageous fees for themselves.

In Australia, hedge funds for ordinary people arrived late, with a handful of stockbrokers offering debt-heavy products to their more sophisticated clients in chunks of $10,000 and more as a starting price.

But if a hedge fund is such a bright idea, why have they been such appalling investments over the past 18 months, as shown in a recent graph published in The Economist newspaper. This compared the Morgan Stanley world equity index (a measure of most of the world’s stock markets) rising from 100 in January 2004 to around 119, a 19 per cent gain. The Credit Suisse/Tremont hedge-fund index rose from 100 to 113, a gain of 13 per cent.

In other words, you would have done better on the general market than you would have playing the hedge fund game.

There are six reasons for the decline of hedge funds.

• Interest rates have risen and the cost of debt to the fund has increased.

• There is a limited range of products available for late arrivals in the hedge fund game.

• There is no longer a yawning gap between government bonds and other forms of investment.

• Fees charged by hedge fund managers are obscene (especially as they are now under-not-over performers).

• There is a whiff of panic in the air as hedge fund managers take on more and more risk.

• Management quality in most hedge funds is poor, and always has been.

Briefcase hopes it is wrong, but current conditions in the hedge fund market have all the hallmarks pointing to a monumental collapse – perhaps triggering a wave of alarm across other financial markets.

Before accusing Briefcase of scare mongering, consider some of the evidence. For starters, there is The Economist graphic, backed up last week by a survey from the Barclay Group, which showed that the overall hedge fund market has started to shrink – from a massive $US1.08 trillion under management to a slightly less monumental $US1.06 trillion at the end of June – in other words, cash is flowing out, not in, which is the kiss of death to any investment class.

If that isn’t enough evidence try this report in Private Banker International, which shows that rich Americans have gone liquid, lifting their cash deposits from 9 per cent of their personal wealth to 13 per cent. Fat cats have become more risk averse, and the first investment they dump is hedge fund exposure.

And, then there’s evidence that institutions (pension funds and the like) are now the major supporters of hedge funds, and never forget that institutions are invariably last to arrive at a party.

But the example Briefcase likes best comes from The Wall Street Journal, which listed a few of the asset classes now attracting hedge funds, including credit-default swaps, aircraft finance, super-catastrophe insurance, legal settlements going to appeal, and leveraged management buy-outs.

Not only do fund managers lack experience in any of these categories, they’re still charging huge fees which are estimated to be around 7 per cent of the value of the fund – which is more than the long-term return on stock market investments.

And to cap it all off there are these unforgettable words from Charles Munger, partner of the legendary Warren Buffet in the Berkshire Hathaway group, arguably the most successful investment company in history. Munger said, when the hedge funds were booming in a low interest rate environment, and doing little more than play a leverage game that: "Never have so many people made so much money with so little talent."

Today, with interest rates rising, and most markets (including property and shares) at a peak, it has become a time for patience, and an acceptance that low returns are the order of the day, and to chase super returns invites super risk.

•••

On a non-investment related theme, public relations practitioners should be taking note of two case studies that cropped up recently – both in the ‘how not to’ category.

First was the case of the man who said too much.

Second was the case of the man who said too little (nothing, actually).

The man who opened up was Bill Turner at Anvil Mining. He agreed to an interview with the ABC Four Corners program some months back about Anvil’s work in the Congo, apparently without knowing what the questions would be. Oops.

Ever since, the likeable Mr Turner has been hounded by the media (especially the ABC) because of unproven allegations that some of its vehicles were misused by the Congolese army in a local massacre.

Lesson one: Know what the questions are, and know the gossip about your own company before the cameras start rolling, because after that it’s all too late.

The man who said nothing was Paul Armstrong, editor of The West Australian. According to what Briefcase heard the other night (should that be, didn’t hear), Mr Armstrong was asked by the ABC to comment on his $5,000 fine for naming a child in a story.

The ABC reported that Mr Armstrong declined to comment – a response which, if accurately reported, is appalling. Here is a man who expects everyone else in the community to respond to questions from his reporters but, when put to the test himself, fails.

Lesson Two: Why, Briefcase asks, should anyone bother to answer any difficult questions from The West Australian when the editor has set the example of silence.

•••

"Gentlemen, I agree with you that Napoleon is a tyrant, a monster, the sworn foe of our nation. But gentlemen – he once shot a publisher." Thomas Campbell’s toast to Napoleon Bonaparte.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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