Hedge funds as risk reducers?

Hedge fund managers continue to reinforce the message that their products aren't high risk offerings, rather they can actually lower risk in a traditional portfolio.

Wednesday, March 6th 2002, 9:32PM

Hedge fund managers continue to reinforce the message that their products aren't high risk offerings, rather they can actually lower risk in a traditional portfolio.

Colonial First State manager Joe Fernandes says that a 5% allocation to hedge funds will potentially increase returns by 0.1% annually and lower volatility by -0.2%. While these look like small numbers the real benefit is in the portfolio's sharpe ratio which will potentially increase by 5%.

A 15% allocation will increase returns by 0.4%, decrease volatility by -0.7% and push the sharpe ratio up 15%, he says.

His colleague, Damien Hatfield, says that hedge funds aren't some way out product. His view is that in five years time they will be mainstream and the term hedge fund won't even exist.

There is a growing view that many of the strategies used by these sorts of managers will be incorporated into traditional funds.

For instance, instead of just having an equity fund which only invests long, more and more managers will start using short strategies in their funds.

Deutsche Asset Management director David Zobel says this make sense as research shows that in a12 month period about half the shares listed on the Australian stock exchange will have positive returns while the balance will have generated negative returns.

By short selling falling stocks managers can make money on shares which are in decline.

Currently long/short equity strategies are the biggest type of hedge funds in the world accounting for about 38% of hedge fund strategies in 1999, compared to 16% nine years earlier.

Managers are becoming more focussed on absolute return funds.

Zobel says one of the key characteristics of hedge funds is that they aim to seek positive returns regardless of market direction.

"Risk (is defined) as a loss of principal rather than performance relative to a market benchmark," he says.

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