Hedge fund hope

PORTFOLIO POINT: There is a reckoning coming that will cull some hedge funds, but the sector will not fade away.
I called my hedge fund this week. I wanted to get some money out (for non-investment purposes). It's a big unlisted fund, OM IP 220, an Australian offshoot of the Man Group, one of the world's biggest hedge fund providers. There was no panic on either side of this transaction. I've had money in the fund for a decade; it's made 17% a year.

“No problem sir," said the man on the phone. "I hope you'll continue to do business with us."

I intend to.

Things have come to a pretty pass when you can take your money out of a hedge fund and you can't make a withdrawal from a mortgage trust.

As an investor, you have to ask yourself: if hedge funds are really a soon-to-obliterated sector, then how come they're liquid?

How come we don't have more hedge fund collapses? How come the best funds can at least preserve capital when the rest of the Australian market is down 40% (even with today's feeble 1.3% response to last night's 11% rally on Wall Street).

Sure, we know there have been hedge fund problems. There was LTCM, the original hedge fund implosion. More recently, Ospraie and Highland in the US. Locally, Jeremy Reid's Everest fund has been taken off the ASX and privatised. You can indulge in a form of hedge fund schadenfreude if you light upon The Hedge Fund Implode-O-Meter, a website that tracks hedge fund disasters.

But recent postings at the Implode-O-Meter have been slim. The truth is you could just as easily have a site devoted to busted banks: Northern Rock in the UK, Kaupthing in Iceland, Lehman Brothers and Bear Stearns on Wall Street '¦ Babcock & Brown?

I'm not sure hedge fund Armageddon is on its way. I'm sure hedge fund experts such as Chris Gosselin of InfoHedge are correct when they say there is a reckoning coming. Gosselin says that international funds generally operate on 90-day redemptions .Assuming it's even half-true that hedge funds had a wave of redemptions in September, then we should see the great reckoning before the end of the year.

There is going to be a hedge fund shakeout '¦ as there will be a shakeout in every industry from investment banks to inkjet printers. But don't expect hedge funds to fade away; the best will emerge from this crisis with enormous goodwill and the systems in place to fire again. They may rebrand as “absolute return funds” but there will be winners here.

One of the key structural challenges facing the wider industry is the evaporation of the prime broking activities at big Wall Street banks such as Goldman Sachs and Morgan Stanley, but I don't doubt the banking talents that created the hedge fund sector will surrender their performance fees or egos to the market. They'll find new solutions.

The best funds deliver on their promises. They offer returns often uncorrelated to markets: long distance hedge funds have pulled in high returns through the dotcom crash, through the Asian crisis, through September 11 and through this year to date. If a manager is pulling in 10% plus in these markets you'll pay the performance fees with a smile.

HFA, the locally listed fund managed group, this week reported a 2% drop in its international fund against a 24% drop in the MSCI. Eureka Report columnist Tom Elliott reports his MM&E Capital fund is down 3.4% for the year against more than 40% for the ASX over the past year. These are not universal figures, and the hedge fund industry is notoriously opaque, but anyone with money in the best funds is doing very well indeed, and when the market stages a genuine all-inclusive recovery rally they'll make profits from that, too.

Meanwhile, a whole generation of retirees who trusted mortgage fund managers – namely AXA, Australian Unity, Colonial Fist State, and Perpetual – to “see them right” have been left high and dry. Forget about a government guarantee for mortgage trusts, the lobbyists have made no progress. Mortgage trusts have no future.

The bitter irony for mortgage trust investors must be the slow realisation that they were taking relatively big risks for returns that were only equal to, or worse than, returns offered for cash.

As Scott Francis pointed out last Friday (see Last rites for mortgage funds?), many funds simply offered near-cash rates; Perpetual's three year average of 6.6% did not even match the bank bill rate!

Adding insult to injury, mortgage fund investors had to fill out a prospectus, while mortgage trust alternatives such as online cash deposits are liquid, at-call and pay a rate that is so similar it hardly matters to most.

I am never going to invest in a mortgage trust, but I'm looking for the hedge funds that will be long term winner. And I bet I'm not alone.