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Portfolio > Alternative Investments > Hedge Funds

Full Speed Ahead for Hedge Funds

By Jeff Joseph

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SEC regulation, demand for additional transparency, and tales of occasional fraud are but speed bumps on a trajectory that could see hedge fund assets quadruple by the end of the decade,” according to a 200-page assessment just released by Cerulli Associates.

The Boston-based research firm’s Hedge Funds: The Market for Absolute Returns provides insights to distributors of alternative and traditional investment products seeking to assess financial advisors’ appetites for hedge funds and absolute return vehicles.

Cerulli (www.cerulli.com) refers to hedge funds as a “booming business” partially fueled by the bear market in equities from 2000 to 2002, and the anticipated bear market in bonds. Moreover, the report notes that although a variety of non-hedge fund alternatives such as real estate, TIPs, and energy investments have been widely popular in recent years, these investments have “significant drawbacks” and may not be such effective diversifiers due to their higher correlation with equities. In addition, they may not be as effective risk-reducers because they display greater statistical and/or fundamental risks than hedge funds.

The report rises above the more pedestrian observations and biases of some less informed studies and financial journalists that so frequently have difficulty seeing past occasional accounts of manager blowups or frauds. With refreshing insight, Cerulli acknowledges that the financial press has not been flattering to the hedge fund industry in noting that “risk reduction and consistent single-digit returns do not make for sexy stories.”

A significant portion of the study assesses the present status of the trend toward the convergence of absolute return strategies and mutual fund structures. The byproducts of this trend–mutual funds with hedging strategies, or hedge fund mutual funds (HFMFs), as the report refers to them–are noted for their popularity across RIA groups due to their familiarity and comfort with the ease of use of mutual funds, as well as the funds’ liquidity, transparency, and regulatory oversight.

Cerulli suggests that advisors are looking for more HFMF diversity and offerings, noting that 50% of the advisors surveyed for its report said they would be more likely to invest in hedging strategies if there were more HFMFs.

With respect to the ability of the hedge fund industry to continue to absorb continued inflows, the report cautions that although “capacity” is ultimately an issue, that day is not nearly at hand. The unconstrained nature of hedge funds does not allow for their popularity to be misconstrued as a bubble, such that they are not limited to one sector, like real estate or Internet stocks, or even to stocks and bonds, for that matter.

Cerulli expects the industry will continue to grow, as will the breadth and diversity of product offerings in the HFMF space. The primary drivers will continue to be investor attraction to investment products that seek absolute returns, as well as their interest in non-correlated investment strategies and techniques.

“The rise of hedge fund investing is predicated on a different way of thinking about portfolio management. This is a sea change, and while perhaps not permanent, we see it gaining momentum over the next 5 to 10 years,” the report concludes. “The metaphor of the traditional long-only manager running money with one arm tied behind his back is a very powerful one.”

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