UK Only Article:  standard article Issue:  A way out of the woods Fly Title:  The lexicon of hedge funds Rubric:  The industry’s language is changing Dear investor, In line with the rest of our industry we are making some changes to the language we use in our marketing and communications. We are writing this letter so we can explain these changes properly. Most importantly, Zilch Capital used to refer to itself as a “hedge fund” but 2008 made it embarrassingly clear we didn’t know how to hedge. At all. So like many others, we have embraced the title of “alternative asset manager”. It’s clunky but ambiguous enough to shield us from criticism next time around. We know we used to promise “absolute returns” (ie, that you would make money regardless of market conditions) but this pledge has proved impossible to honour. Instead we’re going to give you “risk-adjusted” returns or, failing that, “relative” returns. In years like 2011, when we delivered much less than the S&P 500, you may find that we don’t talk about returns at all. In this sectionBeyond the edge The …

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TOTAL hedge-fund assets under management ended 2011 a smidgen over $2 trillion, according to Hedge Fund Research, having fluctuated around that figure throughout the year. Net capital inflows were over $70 billion, half of which was allocated to relative-value strategies (mostly based on fixed-income instruments). The tough economic climate prompted investors to adopt a risk-averse attitude and seek quality assets. Relative value was the best-performing strategy, but even so it only managed to eke out a return of 0.5% (net of fees). Total returns in the composite index fell by over 5% in 2011, the second-worst year since records began in 1990. Equity hedge, macro and event-driven indices declined by 8.3%, 3.8% and 2.8% respectively. They attracted net inflows of $27.9 billion. A recent survey by SEI, a financial-services firm, found 38% of institutional investors expect to increase their allocations to hedge funds this year, down from 54% in 2010. Redemption notifications in January were at their lowest since 2008, when records began, according to GlobeOp, a hedge-fund administrator. This could be because they cannot get better returns elsewhere, or they learned a lesson from 2008 and decided not to liquidate at what they think might be a trough before a rebound. Alternatively, it may simply be a calm before the storm. Redemptions, which tend to occur on a quarterly basis, …

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David Einhorn, the boss of Greenlight Capital (pictured), a large American hedge fund, is usually the one to point out the errors in others’ ways. He has been a vocal critic of companies, such as Lehman Brothers, which he shorted before its collapse in September 2008. But yesterday Mr Einhorn was the one facing scrutiny. He and his firm were fined £7.2m ($11.3m) by Britain’s Financial Services Authority (FSA) for trading on inside information relating to an equity offering for Punch Taverns, the largest pub and bar operator in the United Kingdom.

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UK Only Article:  standard article Issue:  The visible hand Fly Title:  State capitalism’s global reach Rubric:  How state enterprise is spreading THE HEADQUARTERS OF China Central Television, designed by Rem Koolhaas, a Dutch architect, looks like a monstrous space invader striding across Beijing. The headquarters of the China National Offshore Oil Corporation resembles an oil tanker emerging from a shimmering sea. It was designed by Kohn Pedersen Fox, an international firm of architects, and sits directly opposite China’s ministry of foreign affairs. All over central Beijing you see state companies erecting giant monuments to themselves, reflecting their huge power and their vision of themselves as agents of modernisation. That vision is not confined to Beijing. Petronas, Malaysia’s state-owned oil company, has built 88-storey twin towers in the heart of Kuala Lumpur. In Moscow, VTB, Russia’s second-largest state bank, has its headquarters in a sleek glass skyscraper in the spanking new Moskva City Business Complex. The most striking thing about state-owned enterprises …

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ON JANUARY 18th the Securities and Exchange Commission charged seven hedge-fund managers and analysts as well as two hedge funds with insider trading. The alleged scheme involved insiders at Dell Computer and Nvidia Corporation, a chipmaker, passing along confidential information about the companies’ performance, which helped the two hedge funds, Diamondback Capital and Level Global, make $78m.

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FURTHER to the latest column on hedge fund returns, Michael Edesess of Fair Advisors draws my attention to a fairly damning paper on the subject by Adam Aiken, Christopher Clifford and Jesse Ellis, three US academics. The paper tackles the problem of self-selection bias that can mark hedge fund indices (only the best funds choose to report) by looking at funds that have registered with the SEC (which requires them to report performance data). They can then compare the returns of those funds that report their numbers to the index providers.Broadly speaking, there are two effects; first among funds that remain in commercial databases and second, in those that drop out. The authors look at the so-called alpha of funds (jargon for skill) that voluntarily report their numbers. This is a complex calculation since one has to know the portfolio allocation of managers; much of their return may be down to exposure to the S&P 500 or to corporate bonds and so would be classed as beta (simple market exposure that can be obtained at much lower costs elsewhere). Whereas, the managers that report to an index seem to show alpha of 3.5 percentage points, that is because they are the best performers. According to the authors95% of a typical fund manager’s measured skill can be explained by whether they report to a databaseWhen things go wrong for a hedge fund, they tend to stop reporting …

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UK Only Article:  standard article Issue:  Save the City Fly Title:  Buttonwood Rubric:  A devastating analysis of hedge-fund returns Main image:  20120107_FND002_0.jpg HEDGE-fund managers are the smartest investors around. With keen eyes and sharp brains, they spot and exploit inefficiencies in the markets. Or at least that is what the industry tells its clients. There is no doubt that hedge-fund managers have been good at making money for themselves. Many of America’s recently minted billionaires grew rich from hedge clippings. But as a new book* by Simon Lack, who spent many years studying hedge funds at JPMorgan, points out, it is hard to think of any clients that have become rich by investing in hedge funds (whereas Warren Buffett has made millionaires of many of his original investors). Indeed, since 1998, the effective return to hedge-fund clients has only been 2.1% a year, half the return they could have achieved by investing in boring old Treasury bills. In this …

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A HEADLINE on Bloomberg claims (in typical Bloomberg-ese) there was “No Lost Decade for S&P 500 as Big-Cap Bias Masks Rally”. The idea is that, if you equally weight stocks, then they have risen 66% over the last decade.That may be true and I have argued in the past that there’s a lot of scope for alternative ways of weighting portfolios than market values. The Robert Arnott approach, which weights stocks by “fundamentals” like sales and dividends, avoids the peril of market-value weighting, which leads investors to allocate most money to those stocks that are most fashionable, and thus likely to be too expensive.The problem with this approach is that, by definition, not all investors can follow it. If we all equally weighted stocks then, well, all stocks would be equally-weighted. As it is, many stocks are quite small and illiquid so are difficult for big managers to own. Take the Fidelity Magellan fund which had $100 billion at its peak; divided equally among 500 stocks, that would be $200 million per holding. For the smaller stocks, the fund would have 20% of the equity; as it got in and out, it would move the price substantially.    The reason we use market cap-weighted stocks to measure the long-term performance of equities is that they represent the performance of the average investor, before costs. Ten years ago, investors were making big bets on …

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UK Only Article:  standard article Issue:  Into the storm Fly Title:  Hedge funds Rubric:  Hedge funds have had a horrible year—and it could get worse MANAGERS of hedge funds like to think of themselves as seers, skilled in predicting where the market will go next. But today they are staring blankly at their liquid crystal screens and wondering where it all went wrong. The average hedge fund has fallen by around 9% this year; the S&P 500 has fallen by just 3.4%. It is an unwelcome reminder of the past. In 2008, the average fund declined by more than 19%. This year’s euro crisis could be even worse. Managers have diligently researched undervalued stocks, only to see markets plunge after yet more bad news from Brussels. When funds instead position themselves more conservatively and short stocks, the markets promptly rally on the merest whiff of better news. An unaccustomed timidity has seized many hedge funds. They have reduced their leverage, which enhances returns but aggravates losses, too. They are shrinking positions and trading less. There is a “conviction to do …

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EVERY so often, you will hear a European politician rail against the “speculators” who are driving up the borrowing costs of his country. Doubtless, some are playing that game. But it seems doubtful that this is the primary motivation.A hedge fund manager told me at lunch today that meetings with clients often started with the question “What’s your fund’s exposure to peripheral European sovereign debt?”  The right answer to that question is, apparently, zero. If this attitude is common, hedge fund managers will avoid the asset class as an easy way of keeping their clients sweet. Nor do the clients want the managers to short the asset class, lest the Europeans come up with a deal at the last minute.These clients are not sinister, top-hatted capitalists but ordinary pension funds afraid of some embarrassing loss in their portfolio. Their fear imposes a constraint on the people who look after their money. A similar process has happened at money market funds. Which fund manager wants to risk telling the clients they have lost money because of an exposure to Greek or Italian debt, stories that are all over the headlines?Fear is often more powerful than greed.

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