Following the Money Trail: Increasing numbers of
Traditional Investment Managers move over to Hedge Fund Management: An
Analysis
Growth of hedge funds in the past decade
During the decade of the nineties, assets managed by hedge fund industry
in the United States experienced an exponential growth; assets grew from
about US$40 billion in late eighties to over US$650 billion in 2003. Assets
managed by Mutual Funds exceeds those of hedge funds, total assets managed
by Mutual Funds are in excess of US$6.5 trillion.
Continuing boom in the hedge fund industry
However hedge fund assets continue to grow at an accelerated rate, some
hedge fund industry analysts linked such growth to the booming global
equity markets, particularly the technology sector. However the meltdown
in the global equity markets of the past three years totally revolutionalized
the hedge fund industry as many Wall Street investors lost faith in the
stock market as they watched their accumulated wealth wash away.
Asset growth in Hedge fund portfolios were indirectly the result of
many Wall Street investors seeking other methods of investing money, differently
from the traditional “buy and hold” strategy mostly used by
mainstream investment money managers . The growth of alternative investment
strategies were to some degree at the expense of mutual funds, as many
mutual fund companies lost significant amount of capital following the
equity market decline.
Performance of Mutual funds vs. hedge funds
Mutual fund performance is generally correlated with equity indexes,
part of the reason stems from the fact that mutual funds generally take
long positions in the stock markets, expecting that stocks would continue
to grow from one year to another. Such expectation failed during the later
stages of the decade of the nineties; as a result, many mutual fund companies
had negative returns during that period.
On the other hand, hedge funds continued to produce absolute returns
to investors in such strategies. Increasing numbers of financial advisers
and planners started investing in hedge funds according to a new study.
The study, conducted by AdvisorBenchmaking .com showed that about 40%
of investment advisers put their client’s assets in hedge fund vehicles,
up from 5% in the year 2000. Many traditional equity investors who believed
that the bull market would last forever are now seeking for other methods
of investing, and battered stock market bulls are discovering hedge funds
as well.
Joseph Nicholas, chief executive officer of HFR Asset management said,
“It is now clear that there was a lot of spin out there, people
should have been invested in hedge funds, any audience that is considered
suitable for stock investments is more than suitable for hedge fund investments”,
Nicholas added.
Hedge funds outperform mutual funds
Hedge funds, the traditional investment vehicle of the affluent, seems
to be gradually moving into the mainstream, as more mutual fund companies
began considering ways to adopt hedge fund investment philosophy. There
is no agreement however if such democratization would be a positive development
or not.
While mutual funds believe that the equity markets would continue to
grow from year to year, hedge funds in contrast have a more robust and
flexible investment strategy, by going long and or short depending on
management analysis, guts and perceptions of what direction the investment
pendulum points. Such investment flexibility enables hedge funds to continue
to outperform mutual funds in recent times.
The past few years have been particularly hard for mutual fund companies
because of the collapse of the global equity markets. Hedge funds very
easily beat the major market indexes in both the short term and long-term
performance categories. For instance, during the first quarter of 2002
[Bear Market], the S&P 500 had 0.3% return; while the NASDAQ had a
negative return of 5.3% the average hedge fund beat both indexes with
a 1.4% net return.
Comparing longer term performance of mutual funds to hedge funds shows
an even greater margin in favor of hedge funds. In a new released book,
“Hedge Funds: Investment vehicles for the global economy, and what
investors must know about them”, author Paul Oranika compared long
term mutual fund performance to that of hedge funds, according to Oranika,
“from 1987 to 1998 hedge funds had annual return rate of 18.4%,
compared to 10.2% for MSCI World Index, 13.8% for an average US mutual
fund, while the average mutual bond fund had an annual return rate of
7.7%.” What are the implications of this dynamics to managers in
mutual fund industry?
Mutual Fund Managers are following the money trail
It has been reported that many fund managers in mutual fund industry
have been moving over to hedge funds in larger numbers. Hedge fund managers
receive much more in compensation than Mutual fund managers. While Hedge
fund managers are traditionally rewarded with a performance fee, mutual
fund managers are paid mainly on the basis of the amount of assets managed,
regardless of whether the fund is up or down.
Mark Anson of the California Public Employees Retirement System was once
asked what in his view motivates traditional investment managers to migrate
towards alternative investment strategies. Anson replied “Money.
The investment management industry is in the business of gathering assets;
like any other business, the industry looks to increase its revenue base
and its income. Hedge funds allow traditional-long only managers to collect
more assets and earn higher fees. Any industry will naturally attempt
to exploit those venues that offer them highest growth opportunities”
Anson said.
There is another widely held belief that because hedge fund managers are
required to invest their own capital in the fund as well, such inclination
propels them to want to work harder. On the other hand, mutual fund managers
are not required to invest their capital in the portfolios they manage,
they are still paid regardless of the market outcome. However it is still
in the interest of mutual fund managers that their funds do well, on the
long run, if their funds consistently make money, it is reflected on their
track records over time.
Hedge Fund industry attrats top traditional fund managers
Recently, two senior members of Morgan Stanley European equity analysts
left to start their own hedge funds. Stephen Galbraith a well respected
Morgan Stanley strategist based in New York joined Maverick Capital Management
LLC according to released statements. Galbraith would have broad responsibilities,
and would be made part of the principals at the new company. This follows
hundreds of such scenarios in which many traditional investment managers
change over to hedge fund management, some of those managers eventually
launches their own hedge fund.
The trend is also being mirrored internationally, William de Winton and
Colum McCoole, both research analysts with Morgan Stanley in London have
also left to take up jobs at different hedge fund companies. According
to the report, Mr. de Winton is joining Lansdowne Partners, a hedge fund
asset management firm overseeing about US$1 billion, while Mr. McCoole
will be moving over to Plutus Capital Management.
Management houses are competing for top managers in the market, undoubtedly
the hedge fund industry is attracting top traditional fund managers, who
in turn are offered greater compensation packages than what they are currently
earning. There is another case of European’s top celebrity manager
moving over to hedge fund arena. Richard Woolnough for 3 consecutive years
was the best performing manager at Old Mutual Corporate Bond fund. Woolnough
is slated to join M&G Fixed income team early in 2004.
Hedge funds and mutual funds: future trends
The recent mutual fund/hedge fund trading scandals have implications
for the growing dynamics where lines between mutual funds and hedge funds
are increasingly difficult to draw. In fact increasing popularity of hedge
funds due to its absolute return strategies is slowly but steadily being
noticed by mainstream investors. The advent of Funds of funds [hedge funds
investing in other hedge funds] means that smaller non-qualified investors
can pool their resources together to invest in hedge fund managers.
Some mutual fund companies have branched into hedge funds, claiming that
their traditional investors are interested in such vehicles. When mutual
fund groups create and manage hedge funds, it becomes problematic, because
on one hand, mutual funds are regulated by the Securities and Exchange
Commission, while on the other hand, hedge funds are generally not, but
they must conform to the general and broad requirements for hedge fund
investors, such as qualifications etc.
These dichotomies have led to some potential conflict of interest allegations
for instance, a mutual fund manager could buy a stock that hedge fund
manager may sell short, such scenario may lead to a situation where the
mutual fund client may see heavy losses while the hedge fund client sees
gains. Such problem ultimately draws the attention of the SEC and the
Congress to implement new regulations governing such industries. Hopefully
hedge fund’s independence would largely be left intact, because
the hedge fund industry has pretty much held itself in check since the
collapse of Long Term Capital Management of the late nineties. In addition
hedge funds today offer a greater transparency to its investors through
hedge fund web- based portals, such as Hedgeco.net.
Do not write your obituaries yet for the mutual fund industry, it is
a very powerful industry, with over US$6.5 trillion under management.
Once US regulators implement new laws governing the asset management industry,
the anticipated continued recovery in the global equity markets would
help mutual fund industry find its feet once again, in the mean time growth
in hedge fund management portfolios seem unstoppable in the years to come.
Paul Oranika
Editor-in-Chief
Hedgeco.net
Email: oranika@aol.com
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