Peering over the hedge

Date: Wednesday, December 5, 2007
Author: CNN.com

For the modern day MBA student the sector is venerated very nearly as much as that of private equity, while to the uninitiated it is almost as mysterious -- welcome to the world of the hedge fund.

Not only puzzling, hedge funds are also increasingly important -- according to many estimates, they now control combined assets worth well over $1 trillion in total. It is thus no surprise to see hedge funds come under the increasing scrutiny of business schools.

Hedge funds, in the simplest terms, are private, unregulated investment opportunities reserved for the wealthy and financially savvy market player. Unlike regular mutual funds available to everyone, they are free to pursue higher risk, higher return investment strategies and do not offer the protection given by regulated funds.

The funds gained their moniker for the practice of "hedging" risk by offsetting possible losses with other investments, although -- even more confusingly to the novice -- by no means all hedge funds do this anymore.

These days, as well as being a core part of most MBA courses, a series of specialist institutions have also sprung up within business schools devoted to studying hedge funds.

The latest of these is the soon-to-open hedge fund center at Paris's highly-ranked HEC Business School, sponsored by BNP Paribas. As well as being the first such center set up by the French-based global bank in its home city, it is also the first devoted to the specific business model of hedge funds and their management structure.

The first BNP Paribas hedge fund center, opened at the London Business School (LBS) in 2001, examines investment strategies, while a second institution, opened at the Singapore Management University last year, looks at Asian funds.

The importance of the hedge fund industry "is acknowledged worldwide," Bernard Ramanantsoa, the dean of HEC, said.

"It is essential to improve understanding of this growing financial sector notably via fundamental research."

The arrival of hedge funds had overseen "a structural revolution" in third party asset management, noted David Thesmar, associate professor of economy and finance at HEC.

"These asset management firms are constantly evolving, innovating, competing with each other and dying. We must extend our study into their organization and strategy. There is still little research into these issues today."

The key attraction of hedge funds to investors is that their returns can often be enviably high. However, according to one recent business school study of the sector, it's not all positve news.

"In financial markets, when something looks too good to be true, unfortunately it usually is," noted Tarun Ramadorai, reader in finance at Oxford University's Saïd Business School in a joint study with fellow academics at LBS and the U.S.'s Duke University.

One thing to bear in mind, he says, is that hedge fund managers can charge high fees, often 2 percent of assets under management and 20 percent of gains. Additionally, Ramadorai likens hedge fund returns to those on crisis insurance -- so long as no crisis happens the returns are very strong, but the wrong event can cause considerable liabilities.

Finally, he stresses, not all hedge funds are the same, and the good ones often become over-financed as canny investors rush in. This, in turn, can make good returns hard to replicate -- which, as Ramadorai notes, is "unsurprising if you think that there are real constraints on the capacity of managers to come up with good ideas."

So, think you've got a handle on hedge funds. Well, there's another layer to go -- hedge funds of funds.

Luckily, even this confusingly-named phenomenon now has its own explanatory guide, by Dr Chris Jones, who is both a fellow at Cambridge University's Judge Business School and chief investment officer at major European hedge fund Key Asset Management.

A hedge fund of funds is, essentially, a way to dip into hedge funds without necessarily having the in-depth knowledge and expertise needed to pick an individual hedge fund, using instead a collective vehicle that invests across a range of hedge funds.

The book is intended as a "comprehensive and concise" guide to investing in hedge funds in this way.

"There is a sense that the hedge fund world is shrouded in mystery, jargon and a complexity which does not exist in traditional asset classes, and that 'they do things differently there'," Jones notes.

"This book aims to de-mystify some of these myths and to educate such investors, and in particular, to enable them to monitor and benchmark such investments."