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Hedge funds see increased opportunities from market volatility

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Despite a number of high-profile failures in the hedge fund industry and the continuing impact of the credit crunch, many managers believe the market dislocation has created increased buyi

Despite a number of high-profile failures in the hedge fund industry and the continuing impact of the credit crunch, many managers believe the market dislocation has created increased buying opportunities that are positioning the sector well to deliver long-term absolute returns.

Hedge funds have become one of the fastest-growing sectors within the UK’s Association of Investment Companies in recent years, accounting for 23 per cent by value of all investment company new issues last year. They now constitute the fourth largest AIC sector with more than GBP6.6bn in assets out of GBP95bn total for the association, which was established as an industry body for closed-ended investment companies.

So far the AIC hedge fund sector has held up amid volatile markets, achieving a positive return of 8 per cent compared with a 9 per cent decline for the investment company sector as a whole, although risks remain, according to managers taking part in an AIC round table on prospects for the sector in the more turbulent market environment.

Anthony Culligan, manager of the F&C Event Driven Fund, says: ‘The credit crunch means there has been a sharp contraction in bank balance sheets. Banks, by their nature, are leveraged entities and contracting balance sheets means they have had to sell assets to reduce leverage. Some hedge funds that held similar assets to those being sold by the banks have therefore been hurt.

‘Opportunities are more abundant than ever. In senior debt there are top teens returns to be reaped very high up in the capital structure. At the other end of the seniority scale, the equity of high growth franchises can be acquired for single digit price/earnings ratios and double-digit yields. The hedge fund sector is positioned for a supercharged two-year return run.’

BH Macro chairman Ian Plenderleith argues that hedge funds are playing an important role in the restoration of liquidity and a return to properly functioning financial markets. ‘The severe disturbance being experienced in financial markets reflects a complex of different factors, which make it peculiarly hard to read the way forward,’ he says.

‘One is the major adjustment taking place in risk-pricing and the dislocation this has created in core markets in credit risk and liquidity. On top of this are effects from a cyclical slowdown some major economies were already facing and the continued working-out of global imbalances already evident in the world economy for several years, as well as an apparent shift in the demand/supply for oil and soft commodities.

‘All these adjustments, and particularly the process of repricing risk, create opportunities for hedge funds prepared to back their own judgement of where they may feel the markets have not yet reached appropriately priced risk. Macro funds are particularly well placed to take advantage of these opportunities.
 
‘Importantly, it should be recognised that, in engaging with these opportunities, hedge funds are also contributing to the wider public policy interest of enabling markets to function properly.’

Anthony Simpson, co-head of global business development at Ramius, manager of Tapestry Investment, says: ‘As markets evolve through this crisis period and return to some form of equilibrium, there will be substantial opportunities to generate good risk-adjusted returns. The precise timing of these events remains uncertain, but institutions continue to increase their allocations to hedge funds.’

Mark White, chief executive at KGR Capital, which specialises in Asian hedge funds and is an adviser to the KGR Absolute Return fund, says: ‘Asian hedge funds have survived the credit crunch reasonably well as they do not generally rely heavily on high levels of gearing to achieve their returns.

‘The more challenging conditions have provided good opportunities for managers employing strategies that are non-directional in nature – event-driven, arbitrage and equity market neutral strategies have all produced positive returns. We expect a further shift away from the long/short equity strategies which have traditionally dominated Asian hedge funds.’

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