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TASS Asset Flows Mark Cusp of Hedge Fund Strategy

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RYE, N.Y. (–Hedge funds are thought to transcend the volatility of the markets, but stock market trends are affecting hedge fund investors’ allocations and might have contributed to the first quarterly net outflow of assets in more than two years, according to TASS* Research.

In the fourth quarter 2002, TASS reported a net outflow of US$696 million. A flurry of redemptions at yearend undoubtedly is making for an interesting first quarter, when TASS officials expect we will see how investors make amends with an ongoing sideways stock market. The last recorded outflow of assets for TASS was in the second quarter of 2000, said Stephen Jupp, head of database management at Tremont Advisers. That net loss of assets in 2000 totaled US$4.9 billion.

Indications of interest from investors can be seen in the records set in the fourth quarter, as hedge funds continued to report healthy investment returns to make up for the asset loss. The CSFB/Tremont Hedge Fund Index gained 1.07% in December, finishing the year up 3.04%.

Leading the outflow of assets, long/short equity managers reported a record US$2.8 billion in net redemptions. A total of US$4 billion came into the asset class during the quarter, but an unprecedented US$7 billion left the strategy, which is the largest outflow for long/short equity since TASS started to track asset flows in 1994.

Long/short equity might be the most popular hedge fund strategy, but is not an easy place to allocate. “It’s an easy strategy to understand, but picking the best managers is a daunting task,” Mr. Jupp said. The long/short equity returns ranged from a negative 47.9% to positive 84.82% with a median return of negative 1.43% for 2002 in the TASS database.

Millrace Asset Group is one of a number of newer long/short equity managers that has seen interest grow in long/short but has yet to see the assets grow, as investors look for a three-year track record. With a two-year-old strategy, it only has been in the last four or five weeks that investor interest has picked up a bit, said Whit Maroney, partner at the Berwyn, Pa.-based firm.

Allocations seem to be moving into equity market-neutral, fixed-income arbitrage and managed futures strategies. Equity market neutral posted a record quarterly inflow of US$1.3 billion in the fourth quarter, as did managed futures with US$725 million in inflows. Fixed-income arbitrage gained a record $793 million.

Institutional investors could be the source of renewed interest in equity market neutral strategies, according to managers. Michael P. Dever of Brandywine Asset Management, Thornton, Pa., said his firm is seeing increased interest from its institutional and high-net-worth clientele. Still many investors are wary of taking assets away from long-only portfolios, Mr. Dever said.

“Some are saying when it [the stock market] rallies a bit, they will take the money off the table,” he said. “It’s as if the market owes them their money back first.”

That stock market dilemma still seems to be paying off for managed futures managers, though. In December, global stock indexes gave back some of their gains from the previous two months, while interest rates increased, crude oil rallied and gold and silver traded higher, according to managers. Managed futures were up in a year when most all other major indexes were down, with a 5.50% return for December and an impressive 18.33% for 2002 in the CSFB/Tremont Hedge Fund Index.

Asset flows in other strategies were slightly negative for the quarter, according to Mr. Jupp. Global macro, for example, had a small net outflow in the fourth quarter with a number of big redemptions in the database balancing out the US$650 million in positive asset flows.

“Next quarter, we will watch where the pieces fall,” Mr. Jupp said.

Overall for the year, event-driven and convertible arbitrage were the two most popular strategies, gaining a net US$3.4 billion and US$3.2 billion, respectively. Other strategies that were in favor included fixed-income arbitrage and equity market neutral. Dedicated short bias was the only losing category for the year, with a net outflow of US$17.4 million.

*TASS Research is the information and research unit of Tremont Advisers Inc., Rye, N.Y., which is a minority investor in and strategic partner of HedgeWorld.

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