Hedge Funds Get Physical

Date: Tuesday, October 16, 2007
Author: Hedge Fund Daily

Investing in hedge funds no longer involves a virtual or paper chase for higher returns. Hedge funds are increasingly acquiring stakes in physical commodities as a way to boost performance. “Wherever you look, the trend is to move into the physical side of the business,” Gary Vasey of UtiliPoint told Reuters. Hedge funds that specialize in commodities are forming special opportunities funds for the occasion as they get physical to get a better handle on the market. “Generating alpha is becoming increasingly more difficult through the futures markets,” Amine Bouchentouf, president of Renaissance Investment Advisors, said in a Reuters interview,” noting that the influx of traders using similar trading strategies requires hedgies to become familiar with the territory. The advantage to tangible commodities? Physical assets, he says, can generate alpha at a “substantially more attractive level” because “the barrier of entry is high,” Bouchentouf adds, noting, “The returns are more interesting than the futures markets.” There are disadvantages, too.

For one, the above-mentioned barrier. Investing in physical assets requires a lot of capital – at least $300 million to $400 million, according to one estimate -- and so it precludes smaller firms from a piece of the action. And then there are the additional headaches. “When you are dealing with physical commodities, you introduce a whole new layer of risk--deliverability risk, volume risks,” Vasey says. “There is a whole new raft of risks that have to be measured an acted upon and hedged.” True, physical assets carry risk, he says, “but it also [adds] an additional chance to profit.” Among those hedge funds plunging into physical assets, says Vasey, are Centaurus and Saracen Energy, while Reuters reports that Adit Capital and Solius Energy Fund together control 25% of the world’s supply of uranium.