The longer the trend, the more encouraging
An investor from Texas offers his view on hedge funds
YOU SPEAK TO PEOPLE, you learn things. So I welcomed an invitation from Prieur du Plessis, CE of Plexus Asset Management, to spend an hour with his US business partner John Mauldin. They have teamed up here, as Mauldin has in other parts of the world, to form a joint venture alternative investments business, Plexus Mauldin.
Many local investors might know of Mauldin, who’s something of a legend in the global investment world. Based in Texas, he’s president of Millennium Wave Investments, a company that specialises in private money management and alternative investments, like hedge funds and private equity. Mauldin is also a substantial private investor.
And he’s a prolific writer, with his weekly e-letter Thoughts from the Frontline apparently the most widely read investment letter in the world, going out to more than 1,5m readers weekly and posted on numerous websites. He’s currently working on his third book, The Millennium Wave, forecasting how the world will change and how it will look in 20 years’ time.
While in South Africa, Mauldin gave the keynote address at the Raging Bull awards ceremony but I was able to meet with him later between meetings with Plexus’s clients. And as Mauldin is regarded as a hedge fund guru, part of my interest was gauging his views on hedge funds in the future and particularly emerging market hedge funds.
The timing was good. Local hedge fund performance for 2006 has just been released, and over the long term it shows some encouraging trends. For the year to end-December the 12 funds with track records longer than 12 months in the Nedgroup Investments Hedge Fund review delivered an average return of 19,9%.
Similarly, the Nedgroup Investments SA Hedge Fund Index firmed by 19,2% over the year, while the SA Investable Hedge Fund Index run by Clade returned 19,4%.
That’s nowhere near the JSE allshare index’s 41,3% for the year, but it’s also not the point. Despite ongoing concern and scare stories about hedge funds, the good managers aim to offer a low-risk investment with little correlation to equities and therefore offering downside protection and capital preservation.
One measure of this, at least in theory, is volatility as measured by standard deviation. So while the all-share’s spectacular performance showed annualised standard deviation of 13,1%, the Clade index was 5,1% and the Nedgroup Investments’ index 4,4%.
But the five-year trend is encouraging. Lizelle Steyn, manager of alternative products at Nedgroup Investments, has compiled a five-year index linking monthly returns of all participating funds, which includes funds
“One of the worst habits investors have is looking at past performance – not only does it show little,
but it’s probably misleading.”
with shorter track records and those that have closed down. She says the index is calculated to minimise survivorship and self-selection bias. What it shows is that over five years the hedge fund index delivered 22,8% a year at a volatility of 6,7% a year. The all-share, in comparison, was a slightly higher 24,3% a year at volatility of 18,9% a year.
An investor sticking to pure equities did better, but would have been brave to stomach the sharp drop in the equities market from 2000 to 2002. Hedge funds offered nearly the same return on a smoother and supposedly safer ride. That’s the value of hedge funds.
What does Mauldin think of this performance? He’s a little disparaging, not because he doesn’t believe in hedge funds but sets little store by past performance. “One of the worst habits investors have is looking at past performance – not only does it show little, but it’s probably misleading.”
But he also acknowledges problems potential investors in hedge funds have with the aura of secrecy around the funds and regulators that can’t keep up. “I think that in 10 to 15 years the thought of an absolute return fund and hedge fund won’t be novel any more, it will be a routine investment. But it will probably take two recessions for people to realise how hedge funds outperform.”
He also recognises the problem facing average investors. “Innovation in the financial world is occurring faster than regulators can keep up with it. That’s why the rich get access to the best deals.”
For retail investors wanting to explore hedge funds that’s certainly been the pattern. And while Mauldin also favours private equity – “Looking at my personal investments, I eat my own cooking, hedge funds and private equity” – he acknowledges it’s “not a good thing” for retail investors.
“I think private equity funds put a floor under the market, if a company is undervalued they will take it. But it does take potentially good investments away from the regular investor.”
Eating his own
cooking. John Mauldin