Some hedge funds thrive on lack of information
INVESTOR BEWARE
Somewhere in one of the more remote parts of the Russian tundra, there is supposedly a hedge fund employee with an unusual job. His business card may have some made-up title but his real task is go to the local watering holes and buy drinks every night for the workers at nearby oil and gas drilling fields.
The hope is that some precious, price- sensitive information will be let slip amid the shots of vodka. The tale, related to me by a hedge fund contact, is probably apocryphal. But it is not beyond the realms of possibility given the energy and invention of some hedge funds in seeking an information edge from cold- calling suppliers to carrying out intense studies of arcane commodities.
This is not to imply anything illegal, although any trades arising from the Russian story would be dubious. It is more that to justify their lucrative fees, hedge funds look for areas where there are the most pricing anomalies to exploit so they can outperform the traditional fund manager. Two obvious sources of those anomalies are lack of information or liquidity.
That might explain the rising presence of hedge funds in small and mid-sized stocks. In FTSE 100 companies, it is hard to claim there is a lack of research or trading volumes. That is not the case in smaller companies. It is difficult to quantify the degree of hedge fund investment in smaller companies. Many stakes appear under anonymous nominee accounts or fall below the “notifiable” level that is required to inform the stock exchange.
The stakes of other hedge funds that are part of a traditional investment house are often just disclosed under their parent’s name. Some exposure is also taken through derivatives or contracts for difference.
But a survey by Greenwich Associates, the consulting and research house, of pan-European equity hedge fund managers found their level of assets invested in small and mid-cap stocks has risen from 19% in 2003 to 30% in 2005. This represents astute allocation given the outperformance of small and mid-caps in the past two years.
Mid- and small cap brokers also report rising orders from hedge funds. And some hedge funds are regularly popping up on shareholding registers with punchy stakes in companies.
“ They are certainly drilling down into the smaller companies,” says John Pearce, chief executive of the Quoted Companies Alliance, a representative body of small listed companies.