Many hedge fund returns do not justify fees

Date: Wednesday, November 15, 2006
Author: Tom Burroughes, Reuters.co.uk

GENEVA (Reuters) - While hedge funds charge high fees, too many of them earn modest investment returns, and the majority do not deliver better rewards than can be gained from the wider market, industry executives said on Tuesday.

"The real problem is a proliferation of hedge funds getting paid outrageous amounts of money to produce mediocre returns," Alice W. Handy, founder and president of Investure, an asset management company, told a Global Alternative Investment Management (GAIM) conference.

"The key to success is to have the (hedge fund) manager articulate a strategy that you understand ... If you do not (see) these things, then you should not have them in your portfolio."

There are up to 9,000 hedge funds controlling up to $1.7 trillion (900 billion pounds) of assets, according to a number of industry estimates. These funds, which can sell short and use leverage to make money in different market conditions, typically charge 1 to 2 percent management fees and up to 20 percent performance fees -- far ahead of traditional mutual funds.

The average return for all hedge funds was about 7.6 percent in 2005, according to data provider Credit Suisse/Tremont. That compared with a 10 percent rise in global stock market returns, according to the MSCI index of world stocks.

In the first 10 months of 2006, the average return was 9.22 percent, according to data from Hedge Fund Research. Some stock indexes, meanwhile, have performed better, with the Standard & Poor's 500 index rising 10.39 over that period.

DIMINISHING RETURNS

Pension plans and other investors have been pouring money into hedge funds, swelling the market and diluting many funds' returns.

As a result, more funds are likely to disappoint investors by making only single-digit percentage returns in future years, said Larry Kochard, chief investment officer of the Georgetown University Endowment which has just under $1.0 billion in assets.

"Going forward, the average return, on a risk-adjusted basis, is not going to be attractive. It is going to be a challenge for the (hedge fund) industry in general," the senior U.S. investor told Reuters at the sidelines of the GAIM event.

He told delegates that there was also a potential problem in reconciling institutions' demands for decades of strong returns and the rapid turnover of investment managers eager to beat their competitors and gather fresh assets.

"One of the challenges they (institutional investors) face is that there is a very long-term pay-off, maybe five, 10, 15 years," Kochard told the conference.

The GAIM conference is one of the biggest gatherings of hedge fund industry figures since sharp losses at U.S. firm Amaranth jolted the sector earlier this year.

Amaranth, which lost billions of dollars in wrong-way bets in the natural gas market, stirred debate about whether investors should get exposure to hedge funds via a suite of funds run by a third-party manager, known as a fund of funds, or through a single portfolio.

Hedge funds typically aim to beat a market by skilful moves and this factor is known in the industry jargon as "Alpha".

Yet out of the thousands of hedge fund companies that operate, only 5 to 10 percent of them consistently create Alpha for their clients, Andre du Plessis, head of advanced investment solutions at consultants Watson Wyatt, told the conference.

"You don't mind paying high fees providing that you are getting value ... Alpha is very difficult to get at."

Among a number of hedge funds, investment performance is increasingly similar, which is why investors continue to look for niche players with a new money-making strategy, he said.