Hedge funds' glory days seem a long way off as they head into a tricky 2013, with bumper profits likely to remain elusive in markets now dominated by political and central bank action.

Speakers at the Reuters Global Investment 2013 Outlook Summit said the $2 trillion industry, which has disappointed investors with below-market returns this year and losses last year, faces a headache making money in an environment where markets are choppy and not as buoyant.

"We're now (in) a world where we recognize that the ability to make money is a lot more difficult and there aren't that many people who can do it. There simply aren't enough, it just doesn't exist," said Saker Nusseibeh, CEO of Hermes Fund Managers.

"Lots of hedge funds are not making even a positive return. They should be doing 4-5 percent. And they're not ... Suppose it's the smartest people with the smartest models, and they've had 10 years' practice. If you give me 10 years I'm sure I can come back and play the piano badly."

Hedge funds made double-digit returns in seven out of nine years between 1991 and 1999, according to Hedge Fund Research's HFRI index, and made returns of more than 9 percent every year between 2003 and 2007 inclusive amid rising markets.

However, their secret sauce of 'alpha' - profits due to a manager's skill rather than overall market moves - has been hard to find in the 'risk-on, risk-off' environment where markets can be more influenced by the words of euro zone politicians and central bankers than companies' fundamentals.

Funds have lost money in two of the four calendar years prior to 2012, according to HFRI. This year the average fund is up just 2.24 percent to November 23, according to the HFRX index, well behind a 12.1 percent gain in the S&P 500 index .SPX.

Some star managers have been able to thrive in this environment, betting on anything from Greek debt to rising stocks to asset-backed securities.

CQS Chief Executive Michael Hintze, one of the industry's most influential managers, has returned 29 percent from his Directional Opportunities fund in the first 10 months of the year and told the summit he sees a "target-rich environment" in 2013 with opportunities shorting bonds using credit default swaps.

However, fund executives say there may be fewer opportunities for the industry - which has ballooned in size over the past 10 years - as a whole to exploit.

"Alpha delivery can be very difficult. If you have risk-on, risk-off it can be more difficult," William De Vijlder, CIO of BNP Paribas Investment Partners, said.

"There are less big valuation discrepancies around," he added. "You think of 2006 or 2007 and then you think of early 2009 and huge valuation gaps. So perhaps now this is a more difficult (environment) ... When you have something that is very much central bank-led it's much more difficult."

However, De Vijlder said long-short funds, which bet on rising and falling prices but which have struggled as their bets often move in the same direction - may profit as correlations between stocks in an index come down.

Meanwhile regulation such as curbs on naked credit default swaps, short-selling bans and greater reporting requirements could all make life tougher for the sector.

Read the rest of the article here.

Two traders from Goldman Sachs's now defunct proprietary trading desk have started up their own fund, Auscap Asset Management, in Sydney.

Tim Carleton, 31, and Matthew Parker, 36, were forced out of the bank in November last year after the Australian business, Goldman Sachs & Partners, was acquired by its US parent.

The change in ownership subjected the Australian operations to US Dodd-Frank regulatory reforms aimed at making banks safer. One of the provisions of the bill, the Volcker Rule, prohibits commercial banks from making proprietary trades with their own capital.

The pair are not allowed to use their performance numbers at Goldman to market the new venture, but sources estimate the proprietary strategies team, of which they were a part, accounted for one-third to one-half of profits at Goldman Sachs & Partners.

Read the entire article here.

The Australian market has too many domestic and international fund managers and is heading for a major "structural shift", according to chief executive of Bennelong Funds Management, Jarrod Brown.

In an interview with I&T News, Brown said that while his boutique - which manages around $3 billion for a range of Australian institutions - had experienced a "good run, without pumping up our own tyres," the overall funds industry was overcrowded and not all managers would stay in the market.

"I feel we are at full competition in Australia as an asset management community," said Brown.

"There are probably 400 locally domiciled investment managers and another 400 who try and participate. It's a ridiculous situation and they can't all survive. Everyone is after the superannuation dollar, but I don't think we can continue to incubate our own boutiques and also support so many fly-in-fly-out global managers."

Read the entire article here.

Pacific Investment Management Co.'s Bill Gross said structural headwinds will dominate the economic debate no matter who wins the U.S. presidential election.

"The structural headwinds in terms of economic growth, the budget deficit, the fiscal cliff" will dominate political discourse, Gross, who runs the world's biggest bond fund, said in an interview on Bloomberg Television's "In the Loop" with Betty Liu. "It means lower growth. The structural issues are really related to an excessive amount of debt, an excessive amount of leverage that's been built up over 10 or 20 years."

Markets suggest that a victory by Mitt Romney will be better for equities because taxes on dividends and capital gains won't be going up as much as under a second Barack Obama administration, Gross said. Marketable U.S. government debt has grown to $10.75 trillion from $4.3 trillion in 2006.

Stocks will likely gain about 4 percent to 5 percent annually going forward, while bonds may return about 2 percent to 3 percent, he said. The Standard & Poor's 500 Index of stocks has appreciated 15 percent this year. Treasuries have risen 1.66 percent during that span, according to Bank of America Merrill Lynch index data.

Fund Holdings

Gross reduced his holdings of Treasuries for a third consecutive month in September to the lowest level since last October on concern record U.S. debt will lead to inflation.

The proportion of U.S. government and Treasury debt in the $278 billion Total Return Fund (PTTRX) dropped to 20 percent of assets from 21 percent in August, according to latest available data on the Newport Beach, California-based company's website. Mortgages remained his largest holding at 49 percent.

The fund gained 12 percent over the past year, beating 96 percent of rival funds, according to data compiled by Bloomberg. It has returned 8.5 percent over five years, topping 96 percent of comparable funds.

Republican nominee Romney has said he disagrees with the Federal Reserve's unprecedented measures to stimulate the economy and would replace Chairmen Ben S. Bernanke. Suggestions that Republicans would pursue "tight money" policies is likely little more than political rhetoric, Gross said.

"Republican have never really been a tight-money party," he said. "To think that Republicans would be favoring tight money, I think is an election-year type of proposition."

Quantitative Easing

Democrat President Jimmy Carter appointed Paul Volcker, known for taming inflation in the 1980s, as Fed chairman, while Republican President Richard Nixon abandoned the gold standard in the 1970s, Gross noted. Bernanke was appointed by Republican President George W. Bush.

The Fed has sought to drive down unemployment by keeping its target rate for overnight loans between banks between zero and 0.25 percent since December 2008 and purchasing $2.3 trillion of securities in two rounds of a monetary policy known as quantitative easing.

Frustrated by the slow pace of the recovery, the central bank announced Sept. 13 that it would likely keep rates at a record low and also said it would inject more money into the economy by purchasing $40 billion of mortgage bonds per month in a third round of QE.

The U.S. economy is likely to grow about 1.5 percent, according to Pimco Chief Executive Officer Mohamed El-Erian. Gross domestic product is forecast to expand 2.1 percent this year and 2 percent in 2013, according to the median estimate of economists surveyed by Bloomberg.

"There is an extreme difference between valuations that are up here, and fundamentals that are down here," El-Erian, also the co-chief investment officer at Pimco, said on Bloomberg Television's "Street Smart" with Trish Regan. "The equity market has priced in not just an active Fed, but also an effective Fed, and we're getting a question mark as to whether effectiveness is as high as we'd like it to be."

Source - Bloomberg Businessweek

Pacific Investment Management Co.'s Bill Gross said structural headwinds will dominate the economic debate no matter who wins the U.S. presidential election.

"The structural headwinds in terms of economic growth, the budget deficit, the fiscal cliff" will dominate political discourse, Gross, who runs the world's biggest bond fund, said in an interview on Bloomberg Television's "In the Loop" with Betty Liu. "It means lower growth. The structural issues are really related to an excessive amount of debt, an excessive amount of leverage that's been built up over 10 or 20 years."

Markets suggest that a victory by Mitt Romney will be better for equities because taxes on dividends and capital gains won't be going up as much as under a second Barack Obama administration, Gross said. Marketable U.S. government debt has grown to $10.75 trillion from $4.3 trillion in 2006.

Stocks will likely gain about 4 percent to 5 percent annually going forward, while bonds may return about 2 percent to 3 percent, he said. The Standard & Poor's 500 Index of stocks has appreciated 15 percent this year. Treasuries have risen 1.66 percent during that span, according to Bank of America Merrill Lynch index data.

Blackstone Group LP (BX.N) is preparing to launch a multibillion-dollar fund that will buy stakes in hedge fund managers in the secondary market, as traditional buyers such as banks pull back amid disappointing fund performance and regulation.

Blackstone, whose hedge-fund solutions business has $46.2 billion in assets under management, sees an opportunity to provide an exit for banks, insurers and other financial institutions that need buyers willing to take on what are particularly illiquid investments, a source familiar with the firm's plans said.

No target for the size of the new fund had been set, although it could attract between $2 billion and $3 billion, the person said. Blackstone will start marketing the fund to potential investors soon, hoping for returns over 20 percent, the source added.

Blackstone declined to comment.

[Read the full article here]

September's hedge fund performance numbers continue to reflect the buoyancy of the underlying market which has now seen a sustained rally of close to 13% since the low in early June. Not surprisingly September's best results came from Equity 130/30, Equity Long, and Equity Long/Short strategies, with Naos the best performer with a monthly return of 10.69% for its Emerging Companies Fund. For all performance details click here.

While on the subject of performance, a month ago we noted the four-year anniversary of the collapse of Lehman Bros, and the havoc which was to follow. For those of us old enough to remember, today marks the 25th anniversary of the October 1987 stock market crash which wiped 23% off the market's value in a single day. For a few years afterwards the market got the jitters each October for purely psychological reasons. Thankfully that phase has passed although not the tendency for investors to forget the meaning of risk after a few good years.

This week's economic data from China came in as expected, which probably surprised no one, least of all the cynics amongst us that note the almost uncanny resemblance between the Chinese government's projections and the actual numbers, particularly given the speed at which they are produced at quarter's end. However, even allowing for that healthy dose of cynicism, growth of close to 7.5% is nothing to be sneezed at. Anything less and we would undoubtably have all caught a cold.

This week we completed and released the latest AFM Review featuring one of BlackRock Australia's funds. Generally speaking Australia's best absolute return and hedge funds are dominated by boutique and home grown fund managers. As a result it is unusual to see an organisation the size of BlackRock, which globally manages US$3.65 trillion (of which $45 billion is Australian based) show up in AFM's top performing rankings. For the record the BlackRock Australian Equity Market Neutral Fund has an annualised return of 12.54% since inception in September 2001, with volatility of less than 6% and a Sharpe Ratio of 1.26. For a copy of AFM's Review, click here.

For this week's "and now for something completely different" a couple of English lads with too much time on their hands. They'll probably get (or may have got) top marks in their university exams however.

Have a good week-end.

Regards,

Chris.

September hedge fund performance is looking positive at +3.09% with 42% of single fund's performance received, taking YTD results to +7.79%. For full details and returns by sector, click here.

Meanwhile this week I spent an evening sitting in a hotel Restaurant in Melbourne reading the Bloomberg newsfeed on my iPad. It was very sad. Not just the fact that in one of the country's most vibrant cities I was reduced to spending the evening away from home, by myself, with just my iPad, but the news emphasised what a basket case Europe is, and more particularly Greece and Spain are.

Angela Merkel was due to dish out some good old Teutonic austerity medicine to the hapless, tax effective Greeks, protected by some 7,000 riot police. No wonder she only intended staying for six hours before legging it back home to face an equally unhappy home electorate. Today's news tells me that 25% of Greeks are now unemployed.In Spain the economy continues to go from bad to worse with unemployment also at horrific levels, particularly amongst the younger generation, and banks unable or afraid to foreclose on defaulting mortgagees for fear of unleashing a tsunami of property, and probably social unrest, onto the already flooded market.

Meanwhile across the Atlantic it was reported that State Street was charging (yes, charging) depositors for holding Danish Krone and Swiss Francs. And it seems those same depositors are prepared to pay for the privilege of safety.

What seemed apparent from reading these and other reports was that it looks as if there are at least five, and possibly ten hard years ahead for Europe. And if that is the case, probably for the Chinese manufacturing sector as well.

Meanwhile the Australian equity market briefly hit a 14 month high. The Aussie dollar jumped back above US$1.02 in spite of the fact that the economic fundamentals are looking decidedly shaky as the resources boom cools, unemployment is increasing, and retailing/consumer confidence continues to decline.

Go figure.

And for something completely different this week, a grumpy garbo who's behaviour wouldn't look out of place in our Nation's capital...

Have a good week-end.

Regards,Chris.

The collapse of Lehman Brothers four years ago today was the Pearl Harbor moment of a financial crisis that, over the next few months, threatened to bring down the entire U.S. financial system.

Blame for the collapse is still being debated. People bought homes they couldn't afford, peddled by lenders who knew -- or should have known -- that the loans were destined to fail. Wall Street sucked up these loans and sold them off in bundles to investors, sometimes while making bets against those same products.

Everyone should have known better. At the top of this list were the government regulators who are supposed to protect the economy from Wall Street excesses, but who instead sat and watched as a bubble built of rotten subprime loans kept expanding.

Read more

Our CEO, Chris Gosselin, wrote this article last week for the EurekaReport.

When evaluating managed funds, "only performance is reality".

We see all sorts of claims regarding fund performances - both from the managers themselves, in some sections of the media, and in so called "independent" research reports - which try to suggest that a fund is performing well, or has gained a recommended or highly recommended rating in spite of the fact that they have lost investors' money.

There's an appropriate quote from the former head of ITT, Harold Geneen as follows: "words are words, and promises are promises, but only performance is reality".

With apologies to Mr. Geneen, but when it comes to managed funds, and hedge funds are no exception, "performance is the only reality".

In our opinion, neither a rating, a recommendation, nor the soothing words and promises in a fund's marketing material means anything if that fund has failed to perform.  Of course performance means different things to different people (as we've seen recently at the Olympics) but in the field of absolute return and hedge funds it is fair to say that investors should expect a positive return. 

According to the www.fundmonitors.com  database of absolute return and hedge funds, 43% of funds provided a positive 12 month performance to June 2012.  Although 80% of funds in the database outperformed the ASX200 it still leaves 37% of funds outperforming the ASX but failing to provide their investors with a positive return.   Well tried perhaps, but we suspect neither the fund manager nor their investors would be overly happy, and we doubt that Harold Geneen would have been impressed.

What he would have been impressed with however would have been those that provided a positive performance including the following list of the top 10 equity long/short hedge funds over 12 months to June, 2012:

An impressive list, and in these difficult times such performances were difficult to achieve to say the least.  However, as readers would understand, 12 months is not long enough to really gauge a fund manager's performance, and further examination reveals some telling trends.

In recent articles we have shown that various funds and strategies can produce significantly different performances in different market conditions.  What is interesting about the performance of funds in the 12 months to June 2012 is that those with a positive performance over the last 12 months also showed a capacity to perform over the longer term.

It is also fair to say that the strategies that performed in the volatile conditions of the past 12 months tended to be risk averse with low net market exposure, rather than the high conviction, concentrated portfolios that had provided often spectacular performance in previous years, but often with high volatility.

This suggests that the past 12 months have been tough, an opinion which is unlikely to have many readers disagreeing with.  But it also suggests that those funds able to navigate the tough markets of the past 12 months have the necessary skills and capacity to do so over the longer term. 

And some definite trends emerged, further consolidating the benefit of avoiding risk when seeking consistently positive returns over the longer term.

Further investigation showed however that performance over the past 12 months was as good a method as any of filtering risk averse managers and funds.  Only four funds with a positive 12 month performance failed to provide a positive 24 months, and of the remaining, only four fell at the three year hurdle.  Four years became a little harder, with six falling by the wayside, and over five years, a few more.

Finally 26 funds (across all strategies, investing in both equity and non equity type assets) with positive returns over one year also had positive annualised returns over past two, three, four and five years.

That would appear to be enough to really sort the wheat from the chaff, but even within this group of 26 there were some performance measures which still required refining, most notably the intra year drawdowns in 2008 at the height of the GFC.   With the market down over 50% from its peak in November 2007 we removed any fund with a drawdown of 20% or more, leaving just 17 funds remaining.

Finally we measured each fund's risk adjusted performance as measured by the Sharpe Ratio, arrived at by taking actual returns less the "risk free" cash rate, divided by volatility.  Ideally this should produce a number as close to one as possible, but we took the top ten to produce our list of "best funds".

No doubt there will be arguments from some that this methodology is imperfect, and we readily admit that there more ways than this to filter good funds from bad.  For instance, some investors may not be so concerned about volatility, preferring to just take a fund's long term annualised return as the true measure of performance, and of course what suits one investor's risk and return appetite may not suit another's.

The list below also excludes some newer managers who don't have a five year track record, but somewhere along the way a line has to be drawn.  If good enough they'll no doubt appear in these columns next year, or the year after. 

So stripping away the words and promises of the marketers, here are 12 funds which have provided positive returns over five years to June 2012, while having a drawdown of no more than 15% during that time.    Performances over 24 to 60 months are annualised:  Sorted alphabetically.

By any standard this is an impressive performance from each of the above funds, but to have provided investors with positive returns each year over five years during some of the most difficult and turbulent market conditions is a significant achievement.  The fact that they are all "hedge funds" should dispel the myth that they are risky and speculative, and in fact reinforces one of the common factors amongst all the funds on the list:  First and foremost they consider the risk of loss of capital as more important, or at least equally important as providing a positive return.

Remember, "only performance is reality".

Chris Gosselin