21 January 2014
By Jarrod Brown, Chief Executive Officer Bennelong Funds Management. (As published in Deloitte’s Performance magazine – Issue 12, September 2013.)
Although the term ‘hedge fund’ has arguably meant a less-than-perfect experience for many northern hemisphere investors since the onset of the global financial crisis (GFC), in Australia, the investor experience has been remarkably positive – not only in quantitative terms of performance and risk, but also in qualitative aspects such as accessibility, liquidity and fees.
This is particularly so in the case of equity-based funds.
According to independent data from research firm Australian Fund Monitors (AFM), (covers more than 300 Australian absolute return and hedge funds), its AFM Equity Fund Index – which tracks 199 Australian-offered funds – out-performed the S&P/ASX 200 Accumulation Index over the period January 2003 to November 2013, with a return of 12.08% per annum as compared to 10.24% per annum respectively.
The universe of funds covered by the AFM Equity Fund Index covers a range of strategies, including market-neutral, long-only, income, long/short, buy/write, even-driven and 130/30.
Beating the market – with less risk
Importantly, equity-based funds have out-performed the market with less risk. The standard deviation for the AFM Equity Fund Index was 7.75% per annum, versus 13.33% per annum for the S&P/ASX 200 Accumulation Index. In terms of the largest drawdown, the peak slump for the AFM Equity Fund Index, at -25.22%, was significantly less than the largest drawdown for the S&P/ASX 200 Accumulation Index, which came in at -47.19%.
Taking a more recent performance comparison, for the period of January 2008 to November 2013 –isolating the impact of the GFC– the performance of the AFM Equity Fund Index return again exceeded that of the S&P/ASX 200 Accumulation Index, with a return of 5.75% per annum, as compared to 1.58% per annum.
The risk comparison again favoured absolute return funds. The standard deviation for the AFM Equity Fund Index was 8.79% per annum, versus 15.90% per annum for the S&P/ASX 200 Accumulation Index; the largest drawdown is 23.97% as compared to 44.13% respectively.
From this data, the case can be made that both over a long-term comparison comprising a bull and bear market, and over the more recent GFC-followed-by-recovery period, absolute return equity funds out-performed the market’s total return, and took on less risk to do so.
Tapping into the skills of the best
The performance data backs the proposition that hedge funds definitely have a role to play in a diversified portfolio designed both to generate and protect wealth. The diverse range of hedge funds available in Australia (and globally) may be relevant for superannuation fund members, pensioners and ordinary investors alike, where the specific strategies help them to meet their investment objectives in a manner that is acceptable to their specific risk/return parameters.
One example may be an absolute-return equity strategy’s ability to reduce volatility when blended with long-only equity strategies. Another may be a hedge fund strategy’s ability to provide exposure to stock-specific risk while remaining market neutral.
An example close to hand is our Bennelong Long-Short Equity Fund, which has been closed to new money. It is a research-driven, market and sector neutral pairs trading strategy investing mainly in large cap stocks from the S&P/ASX 200 Index, with a 10-year track record and annualised net returns of more than 20%.
The fund’s portfolio manager, Richard Fish, has more than 25 years of market experience. Since inception in January 2002, the fund has earned positive returns every year, including an 11.95% return in calendar year 2008 and 20.6% in calendar year 2011, both of which were negative years for the S&P/ASX 200.
Similarly, Kardinia Capital manages Bennelong's second hedge fund. The Bennelong Kardinia Absolute Return Fund has delivered investors 14% per annum over seven years. This 'variable beta' (which means the manager has the flexibility to adjust the Fund’s exposure to the underlying market) strategy has ensured a positive return in every calendar year since inception in 2006. This obviously includes the heart of the Global Financial Crisis in 2008 when the Fund returned positive 0.30% whilst the market fell close to 40%.
A fund showing that calibre of consistent long-term out-performance across periods of positive returns as well as periods with volatile and negative markets, is demonstrably a very handy addition to any investor’s arsenal.
Part of the reason why hedge funds are under-utilised by Australian investors are various commonly held misconceptions in regard to relative cost, risk, apparent illiquidity and supposed lack of transparency. In the main, these perceptions come from sensationalised overseas headlines. But once investors and their advisers are able to open their minds to the potential strengths of hedge fund strategies – and how they may enhance investment outcomes –an allocation to these vehicles will become more popular.
Value, transparency and access
On the fees front, generally speaking, Australian funds are cheaper than their global counterparts. Broadly, hedge funds are characterised by the notion of ‘2 plus 20’ – 2% a year management fee, and 20% performance fee. While this is common, it is by no means the template for all hedge fund fee structures: what is most relevant to this discussion is that according to AFM, the average fee of funds in its database is 1.3% a year management fee, and 13% performance fee. This only improves the relative attractiveness of Australian absolute return funds compared to long only and indexed equity managed funds.
When it comes to transparency, the characteristics of the Australian investment market are such that opaque hedge funds do not get supported. The channels in the Australian investment market by which money reaches fund managers are strongly intermediated; managers need to be able to articulate their value proposition (including process, performance and regulatory compliance) in a manner acceptable to both the institutional and retail value chains.
In the wholesale market, entities such as asset (or investment) consultants, professional research houses, and wholesale investors’ investment committees and trustee boards all represent ‘boxes that must be ticked’ for a fund manager to be awarded money. In the retail market, ‘gatekeepers’ include research houses and financial adviser dealer groups’ approved product lists (APLs), which go hand in hand.
At no stage within these hierarchies is opacity or ‘black box-style’ investment strategies rewarded – in fact transparency is demanded otherwise managers will not attract fund flows. This makes the Australian market different to the North American market, where there is a larger community of sophisticated investors such as limited partnerships and high net worth investors prepared to invest in funds on the basis of an information memorandum, unadvised. The ‘retailisation’ of the Australian market effectively prioritises and rewards transparency, and it is considered an essential requirement for managers.
The same is true for liquidity, which is effectively in-built as a requirement in the Australian marketplace. If you are offering a retail fund, you cannot have investors locked-up for any significant length of time. There are a variety of methods managers use to manage liquidity and redemptions, but again, the market looks for – and rewards – greater liquidity. In particular, retail investors need daily liquidity.
Hedge funds a growing sector
In conclusion, strong performance, achieved with less risk, cannot go unnoticed, and absolute return funds are fielding much more interest than ever before. According to data from research house Rainmaker Information, the Australian hedge fund sector now manages about $37 billion of the Australian superannuation pool, compared to $20 billion just prior to the GFC. While that still only represents less than 3% of total assets, we are looking more at the growth rate than the total quantum of funds. There is significant room to grow.
It is also note-worthy in this regard that the ‘apex predator’ of the Australian funds management industry, the $82 billion Future Fund (the Australian government’s quasi-sovereign wealth fund), is a big investor in what it calls ‘skill-based strategies,’ across a variety of asset classes, using a combination of fund-of-funds and direct hedge fund investments. The Future Fund, established in 2006, is the biggest user of hedge funds in Australia, although it recently lowered its alternatives allocation from 16.3% to 15.3%, according to its March 2013 quarterly fund update. Having such an influential investor so committed to hedge funds cannot help but increase awareness of the sector.
So while hedge funds might not be suitable for everyone – and their structures, strategies and risks certainly require additional research and understanding on the part of the investor – the reality is that the best funds provide outstanding performance with significantly lower volatility than traditional managed funds. There is possibly not an investor in Australia who is not at least interested in that proposition.
Data source: www.fundmonitors.com
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