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Thursday October 06 2022
Hedge Funds - Tailoring Risk and Return

Personal Wealth Weekly November 12, 1999

by Stephen Cranston



Creating predictable results


        A fund of hedge funds should produce a higher, more predictable return for a lower level of risk than other investments.


        This is the founding principle of the fund of funds suite marketed by Magnum Fund Management.


        Magnum executive chairman Dion Friedland set out the argument for hedge fund investment at the third FM Hedge Fund Symposium last week.


        Friedland says that a fund of funds can blend truly diversified, uncorrelated strategies by managers with a proven ability to control risk in times of major market disruptions.


        Investors must start by choosing their strategies. They need to decide on the targeted investment return and then the mix of strategies can be chosen.


        As well as a targeted return, investors need to determine how much volatility they are comfortable with.


        Friedland says you follow the crowd at your own risk. Reliance on track records is usually a cover-up for lack of understanding of the qualitative factors that differentiate successful managers.


        But track records can be useful in determining the success of funds using relative value strategies.


        Nonetheless, even consistent funds can be hit by unexpected events, such as the emerging market crisis of August to October 1998. Over that period a number of funds with a multiyear track record of consistent returns with less than a 5% standard deviation suffered losses of more than 10%.


        Most managers enjoy their best returns when they have relatively modest amounts of money under management. And most specialised niche strategies can only effectively handle up to a few million dollars or rand.


        Hedge funds have one advantage over unit trusts as they are usually closed-end. If an investor wants to buy units he has to buy them off an existing investor. But hedge fund managers can make more money from annual fees and, potentially, from performance fees with larger funds.


        Friedland says that, to control risk, investors must understand the risks in the various investment strategies. Above all, it is essential to diversify.

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