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Hedge Investors on Cautious Tack in Choppy Markets

Date: Friday, August 22, 2008
Author: Laurence Fletcher, Reuters

 LONDON (Reuters)—Funds of hedge fund portfolios are battening down the hatches in the current volatile markets by building up cash or steering clear of strategies with too much exposure to market movements. With returns in the hedge fund industry hard to come by as the credit crisis continues to hit markets, managers who hold portfolios of hedge funds have become wary of strategies that could be caught out by another sharp downturn.

"These are the toughest conditions I've seen in 16 years," said Ken Kinsey-Quick, fund of hedge funds manager at Thames River Capital, who expects billions of dollars more of asset sales by banks. "We're expecting a big leg down in all financial assets…. We do think in the short-term we don't want much beta."

Beta means exposure to overall market movements. Mr. Kinsey-Quick has built up cash balances of 10% to 15% across his portfolios and has hedged out his exposure to market movements by buying index options.

The move comes as the $2.6 trillion hedge fund industry, which is meant to be able to make money in all market conditions, faces one of its toughest challenges to date. Funds lost 2.11% in the first seven months of the year, according to Credit Suisse/Tremont.

July proved a particularly tough month as bank stocks—which many hedge funds had been betting would fall—rose and commodities—which many funds had owned—fell. Even strategies such as managed futures, which bet on trends in global futures markets, and global macro, both of which had delivered strong returns in the first half, suffered substantial losses in July, making it tougher for allocators to pick a sure-fire strategy.

"At this stage there's not an obvious single strategy," said Tim Gascoigne, global head of portfolio management at HSBC Alternative Investments. "You want to stick to good managers with good risk management and strong infrastructure and do your due diligence."

He said he has been gradually increasing exposure to market neutral strategies, which aim to make money regardless of whether markets are rising or falling.

Meanwhile, Mr. Kinsey-Quick has recently only allocated to strategies that are not correlated to traditional markets and which he believes are likely to make money in the next few months, including those involved in insurance, electricity trading and shipping.

By Laurence Fletcher