Managers confront baffling array of hedge funds

Date: Thursday, January 24, 2008
Author: Dane Hamilton, Reuters.com

BOCA RATON, Florida, Jan 23 (Reuters) -- Worried about tracking error risk in your portfolio? Do you know your performance attribution with your 130-30 fund? Or its dynamic leverage policy? To enhance your alpha generation, are you long beta or gamma?

For portfolio managers looking to expand into the arcane world of hedge funds, those questions may be cropping up on a daily basis as they wrestle with a baffling array of choices in the ballooning world of new investment choices.

"It's a lot more work than it used to be," said Dennis Hammond, chief executive of Hammond Associates, a St. Louis consulting firm that advises pension funds and others on investment choices for some $60 billion in assets. "It's all about complexity."

At one of the largest gatherings of hedge funds, consultants and investors here this week, participants were confronted with more choices than ever before as they listened to dozens of presentations by hedge fund managers.

The industry, which emerged as a cottage industry with some $40 billion in 1990 and has exploded to nearly $2 trillion today, now offers an ever-increasing array of more complex investment strategies in equities, credit, commodities and other securities.

And institutions such as pension funds, under pressure to meet liabilities in ever more volatile markets, are under increasing pressure to look beyond traditional long-only fund managers to generate coveted above-market returns that hedge funds often promise.

Many see "alternatives" like hedge funds as essential diversification moves.

But with about 10,000 hedge funds devising trading strategies in virtually any types of assets and securities, it has gotten exponentially more difficult to choose funds that generate the above-market -- or alpha -- returns that are expected from hedge funds, experts say.

"There are more hedge funds than there are stocks in America today," Steven Galbraith, a limited partner in Maverick Capital, told hundreds of investors this week at the GAIM 2008 conference. "The stakes are just so much higher today to generate alpha."

For many investors, the choice is clear: put money into established multistrategy hedge funds with track records of investment success. As a result, the number of hedge funds holding $5 billion or more in assets has swelled to over 100 today from less than a dozen in 2000, according to industry estimates.

While the average hedge fund outperformed the widely used S&P 500 index .SPX last year, building a portfolio of above-average hedge funds is no easy task, investors say.

But the alternative -- simply staying in long-only funds -- isn't an option, since those funds are mostly barred from using hedge fund tools like shorting, leverage and derivatives, experts say.

"I predict there will be no more long-only mandates in five years," said Charles Krusen, partner in Alpha Equity Management, a $225 million investment firm that is developing new so-called 130-30 strategies -- a fast-growing breed of long funds that allow some shorting to hedge investment risk.

The use of shorting -- or betting on a stock's decline -- is new territory for many long managers, Krusen said. But he said many will be forced to learn the strategy in coming years. And the results may be disappointing for many investors.

"Most of the models for security analysis weren't developed to identify stocks that are overvalued and will revert to the mean," Krusen said. "There will be managers who will learn at investors' expense how to short." (Editing by Jeffrey Benkoe)