PROFIT FROM DIFFERENT MARKET CONDITIONS?

ABN AMRO Asset Management's recently re-launched the ABN AMRO Multi Strategy Fund, available with a minimum investment of S$20,000 is a hedge fund-of-funds (HFOF) managed by ABN AMRO's Alternative Investment Group (AIG) team.

Hedge funds aim for absolute returns while equity or fixed income mutual funds are usually compared in relative terms to benchmark returns. For example, an Asian fund may be benchmarked against the MSCI Asia Pacific ex-Japan index as a means of tracking the performance of the fund against an index representing a selection of stocks based on various factors like market capitalisation and liquidity. But a fund can beat the benchmark, yet register negative returns.

Hedge funds have a low correlation to equity and bond markets, so they should be able to provide returns when the market is up or down. And this makes them rather ideal for investors who are looking to diversify their portfolio. Hedge funds achieve equity-like returns, but with the volatility of bonds.

According to ABN AMRO, over the last 12 years, hedge funds managed to return 15.2%, compared to 10.6% for equities. Furthermore, during bad times, hedge funds provide "insurance" to investors says Herman Barten, Head of Business Development of ABN AMRO's AIG, as they are not as badly hit as equities. In down quarters over the last 12 years, hedge funds lost around 0.7% while equity funds were down by 8%.

Hedge funds employ different strategies to take advantage of market anomalies usually. They can short the market, buy distressed debt, and jump on arbitrage opportunities as and when hedge fund managers deem fit. The skill of the hedge fund manager becomes an important factor then. And this skill can determine if a fund is successful or not. As most hedge funds can leverage their investments - this is perhaps the main reason why investors tend to associate hedge funds as risky - a step in the wrong direction can cause a fund to collapse. Notwithstanding high-profile failures like Long Term Capital Management in the late 1990s, hedge funds have a long term "wind-up rate" of about 8-10% on an annualised basis, Herman concedes.

However, that is when a HFOF may be a good thing. ABN AMRO's Multi Strategy Fund, which has a current fund size of around S$6 million as at mid January 2003, seeks to invest in around 20-30 different hedge fund managers that specialise in different strategies. The primary purpose of HFOFs is diversification, as it spreads out risk. Investing in a single hedge fund may be rewarding if the strategy is effective, but it carries with it a high level of risk.

ABN AMRO's Multi Strategy Fund is currently exposed to arbitrage strategies. Broadly speaking, arbitrage usually occurs when there is a mis-pricing of investments as a result of market inefficiencies. Hedge fund managers can exploit this price gap and earn from it. Another big exposure is global macro strategies, where events happening in the global macro environment like interest rate and currency movements can spark off opportunities for buying or selling.

The ABN AMRO AIG's role is to sieve out good hedge fund managers from a universe of around 6,000 funds and include them in their HFOF. They hold regular meetings with the hedge fund managers to stay in touch with them, and to gauge if strategies are still relevant. So far, there has not been any closure of a hedge fund in their portfolio, says Herman. There are approximately 23 funds in the Multi Strategy Fund as at mid January 2003.

The underlying fund that the Singapore-registered ABN AMRO Multi Strategy Fund feeds into has returned more than 12% (as at end November 2002), net of fees, since inception in April 2000.

The fund has about 50% exposure to the US, 35% to Europe and the rest in Asia. The US exposure was brought down from levels around 75% earlier, while that for Europe and Asia has increased.

Asia, especially, is one region Herman is positive on. He believes that the growth potential in this area over the next couple of years will be high compared to the US or Europe, because it is still relatively untapped. Hedge fund investments in Asia accounts for only 4-5% of the global universe, and there are around 250 hedge funds here. In terms of performance, Asian hedge funds are likely to achieve returns that can be 2% higher than that of US markets, he notes.