New Performance Survey of Australian Absolute Return (Hedge) Funds

The Investment & Technology magazine has published a new performance survey of absolute return (hedge) funds in its 26 March 2007 Issue. The survey has been prepared in association with Standard & Poors, and provides some more colour to participants in the Australian hedge fund industry. The survey shows returns over various periods to 31 December 2006 and two measures of exposure - net exposure (longs - shorts) and gross exposure (longs + shorts). There are 63 funds listed across 30 different managers.

The survey splits single manager funds from fund of funds and bases the classification on the CSFB/Tremont hedge fund strategies adopted in their popular global hedge fund survey. There was some adaption of the strategies such as combining equity based strategies in one grouping.

This survey suffers a little from teething problems around the definition of net and gross exposure (4 funds show net exposure greater than gross exposure) and the 3 year return data where some funds appear to report non-annualised returns while the balance of funds reported annualised returns. One manager showed pre-fee returns which makes comparison difficult. But all these matters are expected to be rectified in future editions which are now expected on a monthly basis.

Focusing on the 1 years returns (post-fee except for one manager) which are likely to be accurate, there is a marked difference in the outcome for single manager funds compared with fund of funds. The median single manager return over the year to 31 December 2006 was 16.8% compared with fund of funds which had a median post-fee return of 10.2% over the same period.

While the returns posted in the survey are good, care needs to be taken to understand the risk taken in delivering these returns - have they been achieved with either net equity market exposure or substantial leverage? Putting aside the data difficulties noted above, it would appear that leverage (as measured by gross exposure) is not particularly high. A typical equity based fund has a long position less than 100% partially offset with a lesser short position.

However, it is the net exposure which may explain a significant part of the return in 2006 and will carry risk in a down market. This is a matter that Peter Smith at van Eyk is expected to focus on in a forthcoming analysis of alpha and beta in Australian hedge funds. Net exposure amongst single manager multi strategy and equity based funds (excluding the 4 funds where net exposure is reported as being higher than gross exposure), where there is a reasonable sample size of 20, was reported as 69% at 31 December 2006. Only 4 funds in the survey appeared to be adopting a market neutral approach (including the TI Intercept Capital Fund with which I am associated). This suggests that the equity based absolute return funds listed in the survey will exhibit positive correlation with the relevant equity market in which they are investing.

Next month the Survey will also include some comparatives with hedge fund index returns.

This Survey is another step towards providing more transparency to absolute return (hedge) funds offered to Australian investors and is to be applauded. It suggests that most funds are operating with limited leverage, although high net exposure to equity markets is a concern for investors looking for portfolio diversification from their hedge fund investment.