The longer the trend, the more en­cour­ag­ing

An in­vestor from Texas of­fers his view on hedge funds

Finweek English Edition - - Creating wealth - BY SHAUN HAR­RIS shaunh@fin­week.co.za

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

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