Multi-strategy funds survive turmoil of Amaranth collapse

Date: Friday, November 23, 2007
Author: Sarfraz Thind, Financial News

Diversification debate continues a year after collapse

When hedge fund Amaranth Advisors imploded with losses of $6bn (€4.1bn) last year, investors re-examined their exposure to multi-strategy funds.
 
A diversified portfolio is supposed to be a less risky portfolio, and the growth of multi-strategy hedge funds in the past three to four years has been linked to this premise.

But whether such funds have always followed the principles of the model is another question. The collapse of Amaranth came about when chief energy trader Brian Hunter took large positions in natural gas futures that moved against him in September last year, leaving the firm facing $6bn in losses from its $9bn assets under management.

The trades were backed by the assets of Amaranth’s other strategies in a process called cross-collateralization, and the whole firm collapsed.

David Escoffier, head of global equities and derivative solutions at Société Générale in London, said: “If the term multi-strategy is a blank check to say you can put all your eggs in one basket then it is not really multi-strategy.”

This kind of contagion risk between strategies led many market participants at the time to predict investors would look to switch out of multi-strategy funds into funds of hedge funds.

However, one year on and multi-strategy funds do not appear to have suffered unduly in terms of asset inflows.

According to statistics published by Lipper, net assets under management of multi-strategy funds grew by about 15% from $347bn to $401bn between August 2006 and July this year.

This compares to an overall 24% growth in the hedge fund sector to $1.24 trillion, according to Lipper – data providers such as Credit Suisse/Tremont and Hedge Fund Research estimate the total at $1.9 trillion.

While returns of multi-strategy funds have lagged funds of hedge funds over the past year, their long-term performance is stronger.

Funds of hedge funds returned 16.94% compared with 15% for multi-strategy funds in the past year, according to figures published by data provider Morningstar.

But the annualized three-year performance stands at 11.72% and 11.75%, respectively, whereas over five years the gap increases, with funds of hedge funds returning 10.94% and multi-strategy funds 12.51%.

Greg Froese, head of investor relations for multi-strategy fund Lionhart – which manages $800m in assets – said the fund suffered no redemptions post-Amaranth, and that while it had a few similar positions in the energy market, these resulted in a loss of less than 1%.

However, he admitted there have been some changes since last year. One of the main differences is the increased calls for transparency from investors to prevent an Amaranth situation from recurring.

Froese said: “People are asking more questions of us. While we do not give out positional data we try to be as transparent as possible. However, we did not experience any repercussions after Amaranth, and have continued to see stellar returns. For us Amaranth was a one-off.”

The question remains whether multi-strategy funds have the flexibility and resources to play across a full spectrum of investment strategies.

Although multi-strategy funds have been able to sell themselves on their ability to switch quickly between different investments depending on where the opportunities lie, many are not convinced by arguments about their risk- reduction characteristics.

Nick Oppenheim, founder of Aida, a fund of hedge funds based in London, believes multi-strategy objectives are difficult to adhere to in practice. He said: “Multi-strategy is a difficult game to execute well.

“It requires a robust and broad skill set across the spectrum and there are not many people who can do that. A fund of hedge funds can pick the best of breed from anywhere in the market.”

Christophe Chouard, managing director and head of sales at fund of hedge fund HDF Finance in Paris, agrees. He said an investor in a multi-strategy fund would have operational and credit exposure to a single management firm, belying the benefits of the strategy of diversification.

Chouard said problems categorizing multi-strategy funds had dissuaded the company from including them in its fund of funds portfolio. Only two of HDF’s more than 200 underlying funds are multi-strategy.

Philip Pearson, head of alternative business development at UK asset manager Morley Fund Management, which has $900m in assets under management, said: “One of the key factors is the contamination risk exhibited in multi-strategy funds. In our experience, investors feel a fund of funds is a safer structure – it’s easier to see where the capital is and how risk is being controlled.”

The statistics seem to bear this out. The risk-adjusted return, or Sharpe ratio, of funds of hedge funds over five years to December 2005 was 1.01 compared with a ratio of 0.66 for multi-strategy funds, according to hedge fund data provider Altvest.

However, proponents of multi-strategy funds argue that sticking to a pre-defined set of investment styles, allied with careful risk control, works.

Lionhart claims to have never had a losing year and Froese said the company believed it was crucial to work within a strict set of investments styles.

Froese added: “ Lionhart has utilized the same business model since our first fund in 1996. Our focus on a set number of specific strategies in which we feel we have expertise, enables us to counter the possibility of style drift.”

But for the largest multi-strategy funds, things may be changing. Escoffier said: “The biggest hedge funds are moving towards an asset management business model.

"This is less like Amaranth – which involved switching from one market to another – but more about having different and separated strategies under one umbrella. It’s rather like a hybrid between a fund of funds and a multi-strategy fund.”

GLG Partners, a UK hedge fund manager that pioneered the multi-strategy approach, demonstrated the appetite for the investment style by raising its assets under management 10% to $20.5bn in the three months to September 30 and this month floating on the New York Stock Exchange.