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Portfolio Talk: Hedge funds smooth rough market

Alliance Capital vice president Kent Moser explains why hedge funds are in vogue and why they are considered an alternative to actively managed funds.

Tuesday, May 8th 2001, 1:26PM

by Philip Macalister

The continuing volatility of investment markets offshore has made people look for protection through alternative types of funds. One of the major beneficiaries of these changes has been hedge funds. While they may have had a bad name for years their image is rapidly improving and in some case they are becoming mainstream.

Alliance Capital, New York-based manager Kent Moser was in New Zealand recently. Good Returns talks to Moser and gets his handle on where hedge funds fit into the investment picture and why they are replacing more traditional actively managed funds.

What's your definition of a hedge fund?

Typically these types of products are long and short, some type of hedged vehicles that at times utilise leverage and are targeting better risk adjusted returns than a more traditional style management in the same area.

What are the key objectives of the hedge fund?

The key objectives are to either increase returns at the same amount of overall risk or achieve the same return with lower risk.

Taking long and short positions are one of the key tools in a hedge fund. What are the differences?

Typically from the traditional stand point a traditional manager is buying stock on the premise that they think it is going up at some point and ideally it goes up sooner rather than later and they achieve their return targets.

Within a long/short strategy a manager is buying stock they think will go up in value and selling stock that will go down in value. The interesting aspect of that is that within that long/short strategy short positions tend to move differently than long positions.

Short positions as a whole tend to move more quickly. Also, short positions decrease in size and value as you make money off them. The opposite happens with long positions. If you're making more money off the long side it keeps increasing in value.

The other aspect of short is that if they go against you loose money and exponentially you lose unlimited amount of money. If the stock goes up for ever there's no limit to what you can lose basically. In a long position if a stock goes down you can only lose to zero.

So having a short component adds more complexity to the management.

But if done right you get into a situation where you are making money on your long and at the same time making money on your shorts ideally or worst case you're making money with your long and your shorts aren't taking away too much money. What its doing is it's controlling or reducing your performance volatility.

Do you use both long and short positions?

In our case all our strategies have long and short positions of some sort and typically we want to try get similar short positions or long positions.

Isn't long/short management what active portfolio managers are meant to do?

An active portfolio manager maybe market timing, between stocks and bonds or stocks and cash.

We are just adding that other component of shorting in case of equities. In the case of fixed income we are adding leverage, plus we are adding insurance. So we can be long a stock or a bond, we can be in cash, we can be a short a bond and we can also use leverage.

So it's an advanced form of active management?

Yeah. Absolutely.

What are the popular hedge styles at the moment?

The biggest so far as overall assets goes right now is long/short. It was global macro maybe 4 or 5 years ago and global macro managers (such as George Soros) were pretty much able to do anything. Long/short managers, who are coming into popularity now, are focusing on adding value on stock selection - both the long and short side.

A long/short manager is someone who is very good on the stock selection process?

Yes, and it could be both the long side and the short side or just the long side or the short side but in addition on one of those sides it would have an active hedging strategy.

You don't run multi-manager funds?

We have a multi-strategy fund and the difference in this case is the fund of fund typically will have an active management style where it is making changes to their allocations across the funds. Our multi-strategy product is just a percentage of various product that's made available to the client who doesn't really want to think about deciding which fund he wants to be in. He just knows he wants hedge fund exposure.

Why are hedge funds so popular at the moment?

One of the obvious reasons is the stock market has been having difficulty recently. Prior to the second quarter last year when the market started topping off a lot of people were lulled into believing that the market returns were in their 20's as opposed to 10,11, 12%. That made it more difficult to persuade or educate people or institutions for that matter, about why they should invest in more absolute return strategies or strategies that were getting some return from the other side not just from the long side.

With the down turn in the market it is definitely making people rethink their strategies. In fact it is making them rethink their passive and their active strategies.

What's happening with the various styles in the US?

The use of passive funds that that have a benchmark index and very tight tracking error is increasing. So too is the use of very active, no benchmark, hedge funds while the use of active management in the middle is decreasing.

Where do futures and options fit into what you do?

Futures and options act as a hedge strategy either on the long side or short side. If we want to adjust our positions or portfolios that is what we use. Also we use over-the-counter instruments like swaps which have become lots more viable than Treasury hedging as far as interest rates are concerned. But for the most part derivatives are reasonably limited

We use them, but we don't rely on them to gain our performance returns.

Hedge funds have bad press in the past, has that been deserved?

On a hedge fund specific basis yes it has been deserved, but it must be remembered that those were specific hedge funds that were in most parts were unrelated to a lot of other hedge funds managers that are were very skilled, very honest hardworking, diligent and good.

Unfortunately if one hedge fund has a problem then two hedge funds have a problem then suddenly it's across all the papers,

Hedge funds are considered a little bit unique and maybe a little more glamorous than traditional management so they tend to gain the spotlight if there is a little bit of a problem.

How liquid are hedge funds?

Hedge funds are not made to be a trading vehicle, it's not like your investing in stock that you can get in and out of.

They are similar to property investments - don't expect to buy a house and get out of it a month later.

You can read Philip's blog here: http://www.goodreturns.co.nz/blog/

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