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Winston Raj

When hedge funds are mentioned, most people will think of George Soros.

But it was A.W.  Jones, a professor and Fortune magazine editor, who first introduced the concept in 1949.

'When, as a journalist, he interviewed money managers, he would ask questions like, 'How do you predict the market?' or 'Can you predict the market?'' says Matthew Dillon, regional manager for Asia Pacific at Man Investments (Hong Kong). 'And all these famous gurus at that time gave the same answer: nobody can predict the market consistently.'

So instead of trying to predict the market, Mr Jones decided to reduce the market's impact on an investment portfolio.

He developed an investment strategy of offsetting long and short positions in the stock of companies in the same industry, thereby hedging macroeconomic factors while benefiting from individual companies' performances.

The A.W.  Jones Group, which was the first hedge fund, used a private partnership as a vehicle for flexibility, sold stock short and employed leverage.

'Mr Jones reasoned that having both short and long positions in a portfolio could increase returns and reduce risk due to lesser market exposure,' says Mr Dillon.

Many hedge funds still follow the structure and strategies laid out by Mr Jones.

One of the biggest myths about hedge funds is that they are only for the wealthy.

This misconception was created by the structure employed by hedge fund managers.

In simple legal terms, a hedge fund is generally structured as a limited partnership, with a general partner responsible for the investment activities and the fund's day-to-day operation.

By exploiting loopholes in the regulatory system, many hedge fund managers structure their funds in a way which takes them out of the purview of regulatory authorities.

For instance, in the United States, hedge funds are required to have a maximum of 99 'high-net-worth' clients to make use of regulatory exemptions.  In addition, hedge fund managers cannot advertise.

'Since you can accept only 99 investors, a hedge fund manager will want to make sure that they are 99 of the wealthiest investors,' says Mr Dillon. 'This gave hedge funds a reputation that they are mainly for the wealthy.'

Also, due to the restrictions on advertising, hedge funds were thought to be investment vehicles only for those 'in the know', he adds.

Mr Dillon feels that this misconception is slowly being erased.

'As people become more educated, they are looking for more flexibility in their investment portfolios and hedge funds are now being assessed by many,' he adds.

There are five ways investors can access hedge funds today, Mr Dillon says. The first way is through a single-manager fund. 'This tends to have a higher volatility and higher return strategy,' he says.

The second way is to access what is called a style fund. This means selecting a single style - such as arbitrage, long/short equities and so on - but allocating it to multiple managers. 'So you are diversifying your manager risk, but you are making bets on the style or strategy,' Mr Dillon says.

The third way is called a fund of hedge funds, 'where you are doing multiple strategies with multiple managers', says Mr Dillon. 'This is the most popular way for most institutions and new investors to access their funds because it does tend to be the least volatile.'

The fourth way is through structured  or guaranteed hedge fund products. These are essentially funds with an added guarantee.

'People like them because in the worst-case scenario they get the principle back from a guarantor bank,' says Mr Dillon.

The last method is investable indices, 'which are tailor-made solutions', he says. 'This is more for the institutional market and it is seen more  in Europe than in Asia.'

The second misconception about hedge funds is that they are highly volatile and risky.

This can be blamed on investors like Mr Soros, whose Quantum Fund 'took bets on macro-global strategies' in the 1990s.

'People started hedging against market risks in the beginning but, after looking at traders like George Soros, they started to think that hedge funds are all about high risk and high returns,' says Mr Dillon, adding that times have changed.

Hedge funds were actually created to diversify portfolios and reduce risk. 'Modern portfolio theory stipulates that adding investments with low correlation to an existing portfolio can enhance the risk-return characteristics of this portfolio,' says Mr Dillon.

Adding hedge funds to a traditional portfolio does exactly that, which Mr Dillon feels is the main reason why the popularity of hedge funds is growing.

The industry is also looking for better regulation and transparency in terms of 'more than just comprehensive risk analytics', says Mr Dillon, who believes such demands will only do the industry good.

'Regulation is needed in order to eradicate fraud and conflicts of interest, and should be applauded where it facilitates investors to access hedge funds and increases the maturity of the market,' Mr Dillon adds. 'However, regulation can also hamper entrepreneurialism and slow the flow of new talent.'



Name of the game is boosting returns  and reducing risk