|
|
 |
|
| Feature |
Hedging Our Bets
John Ferry
11/01/2004
|
James Hedges' family made its money bottling Coca-Cola in the mountain town of Chattanooga,
Tenn. “The formula is in Atlanta, but all the bottling in the world started out
of Chattanooga,” he says proudly.
Through a loose association of
acquaintances, in the late ’70s the Hedges were introduced to an emerging
investment vehicle—hedge funds—that coincidentally echoed their family name. “A
very famous hedge fund manager had a partner who was from our hometown in
Tennessee,” Hedges says. “This guy ended up being Julian Robertson, who ran
Tiger Management. When Julian started Tiger in 1979, they rounded up clients
from Chattanooga, Salisbury in North Carolina, where Julian was from, and San
Antonio, Texas, where his wife, Josie, was from.”
| The issue for many of us is not whether hedge fund investments are
generally beneficial, but rather what proportion of our portfolios
we should actually invest in them. |
The Hedges family got into
the Tiger fund early, and have never looked back. “That relationship with Tiger
facilitated an introduction to Tudor, then Moore, then Steinhart and so on.
These were people we referred to at the time as ‘smart people in New York
running money,’ not knowing that they were ultimately going to become the lions
of the industry.”
And a full-fledged industry it has become. By all
accounts, the hedge fund market is booming. In the second quarter of 2004, the
amount invested in the sector globally pushed past the $1 trillion mark,
according to a survey conducted by the hedge fund trade publication Alternative
Fund Services Review. Indices now track the performance of the hedge fund market
as a whole, and funds of funds vehicles offer broad exposure to a range of funds
with relatively low capital entry levels. “Hedge funds are becoming more
accessible, and the high-net-worth market is making the transition,” says fund
manager Harry Krensky, a managing partner and founder of South Norwalk,
Conn.-based Discovery Capital Management.
TOP VIEW
Hedge funds have evolved from exclusive investments for the “smart
money” to popular and widely used tools that have, for several years, delivered
impressive returns. However, there are a number of issues to consider when we
formulate our strategy for allocating capital to this sector. In the first of a
two-month series on hedge fund investing, Worth examines how biased performance
data, dubious managerial standards and evolving fund strategies lead experts to recommend only a conservative-to-moderate exposure to this asset class. In our
December issue, we will examine how to gain access to the best funds, and what
questions we should ask managers, before investing. |
The surging popularity of hedge
funds is also due to changes in investor perception, as many realize that the
funds can potentially offer positive returns, even when traditional equity and
bond markets are falling. High-profile examples of this in action, such as the
exceptional returns that the Harvard, Yale and Princeton endowments have enjoyed
on their hedge fund investments, have also boosted the market.
Dubious Data
The issue for many of us is not whether to invest in hedge
funds, but how much. Prior to the advent of hedge funds, determining the best
way to allocate our portfolio among different assets was relatively easy. Our
wealth advisors would typically apply the battle-ax of financial modeling, a
nearly 50-year-old insight called modern portfolio theory. This tool helps one
decide how to mix different assets together in order to gain the highest
expected return for a given level of market risk.
Take the example of a
traditional portfolio split among cash, equities and bonds. Using modern
portfolio theory, an investor or advisor pulls together historical data on
returns to calculate the expected return for each asset. The same data is also
used to determine the risk of each asset by examining how much the returns
historically fluctuate—in the lexicon of statistics, this measure is called the
standard deviation. Finally, because diversification is important, the investor
or advisor measures how closely the investments track one another, which is
known as their covariance. These calculations are then put into a mathematical
model that tells the investor what percentage allocation should be made to each
asset class to produce an optimal return for his or her chosen level of risk.
|
|
|
|
|
|
|
