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Saturday October 20 2018
 
The Attraction of Hedge Funds in Times of Uncertainty

Finance Week April 16, 1998

 

      DION FRIEDLAND, managing director of the Magnum Group of funds and the man who lent his name to the Dion retail chain, has succeeded in doing for hedge funds what he did for appliance retailing earlier in his career.

      There are reckoned to be some 4,000 to 5,000 active hedge funds worldwide, representing some US$300bn in investments and growing at the rate of 20% a year. Returns from these funds, measured over the long term, have outperformed standard equity and bond indices with less risk and lower volatility than equities.

 

      One of the main attractions of these funds is their ability to hedge against stock market corrections or crashes through a variety of invest-ment strategies. Friedland says there is a popular misconception that all hedge funds are volatile because they take large one-way bets on currencies, stocks, bonds commodities and gold - known as a global macro strategy. George Soros's Quantum Fund is perhaps the best known global macro fund, but in reality less than 5% of all hedge funds fit this category. Most use derivatives for hedging purposes only, if at all, and many use no leverage.

 

      There are about 14 different investment strategies used by hedge funds, each offering varying degrees of risk and return. A macro fund, for example, invests in stocks, bonds and other investment oppor-tunities to profit from shifts in interest rates and changing economic outlook. The potential returns are huge, commensurate with the volatility. An equity hedge fund hedges against downturns in the stock market by shorting (selling with a view to buying back later at a cheaper price) over-valued stocks or stock indices.

 

      A distressed equities hedge fund buys equity, debt or trade claims of companies facing bankruptcy or reorganisation and profits from the market's lack of understanding of the deeply discounted securities. Such a fund would typically have low to moderate volatility. A relative value hedge fund would take offsetting positions in different securities of the same issuer. It might, for example, go long (buy with a view to profiting from a price rise) on convertible bonds while shorting the under-lying equity, thereby arbitraging the market risk between different securities of the same issuer. This has a low expected volatility.

 

      There are income hedge funds, fund of funds (allowing the investor to mix and match hedge strategies), aggressive growth, emerging market, market timing, oppor-tunistic, multi-strategy and special situation hedge funds, each with a different risk-return profile.

 

      Hedge funds have several advantages over mutual funds. They are more flexible in their investment options because they use financial instruments generally beyond the reach of mutual funds, which strictly regu-late the use of derivatives, short-selling, leverage and spread of investments. Through the use of these investment styles and instruments, hedge funds are. better able to protect against downside risk.

 

      Some of the returns achieved by hedge funds are astounding. The Lancer Voyager Fund was up 123% in 1997, the Trenton Small Cap Fund rose by 83,4% over the 11 months to February 1998 and the Townsley UK Small Cap Fund was up 59% over a similar period. The Wall Street Journal Europe and Asia ranked Magnum Special Situations Fund the best performing fund in the world in its category for the 12 months to November 1997, while Magnum Russia Fund was ranked the best performing fund of funds in the world for 1997 by MAR/Hedge, a journal which tracks the hedge fund industry, with a return of 70,9%. Magnum Aggressive Growth, Magnum Fund and Magnum Multi Fund were all ranked in the top five by FT The International, which measured returns over three years to November 1997.


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