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Thursday, 11th September 2025 |
| The ups and downs of hedging |
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| In July 1998, Kyte Fund Management launched its first two hedge funds under an Irish listed fund umbrella company. In this article, Gilad Hayeem, Kyte’s director of marketing, gives an account of the hedge fund industry vicissitudes during Kyte’s first nine months of trading. |
In September last year, hedge funds became front-page news. In a now infamous episode, Long Term Capital Management was bailed out amid talk of global financial meltdown.
Two months earlier, in July, we had started trading our own hedge fund products, slotting our launch neatly ahead of the Russian and LTCM Crises. The news at the time made depressing reading for a start up fund. To use New Labour speak, headlines like ‘The only way to avoid hedge fund disasters is to avoid hedge funds’ were giving out a very negative message.
A month later, business pages mourned
‘Another Harrowing Hedge Fund Tale’ as they told how ‘....yet another multi-billion hedge fund operation has run into trouble. This underscores just how serious the problems are with these exotic investment vehicles...’.
Nearly all the attributes applied as fact to hedge funds and their personnel seemed to apply to a limited number of funds and to none of those we had visited and researched while setting up.
The issue of leverage was much dwelled upon with the implication being that hedge funds need to employ thousands of percent of leverage in order to make a decent return. Leverage is regarded as risky because it allows a fund to expose itself to potential losses (and of course profits) that can exceed the amount of money it manages. The risk is that, in the event of trades turning against the manager, the fund will quickly lose all of its investors’ monies. In fact, many funds employ no leverage and are still classed as a hedge fund and still make very significant returns.
Another issue that was the subject of much focus was liquidity. Many funds lock their investors’ monies up for six months or a year or more. This varies significantly from fund to fund and much depends on the liquidity of the investment and the investment strategy. For funds which are invested in liquid markets and strategies, our experience was that monthly redemptions were the norm.
A third feature associated with hedge funds was lack of transparency. Historically, hedge funds have been reluctant to disclose details of their investment strategy or philosophy in too much depth generally citing a fear of being copied. Given that most funds rely on a definable trading system or strategy that a trader has developed themselves over a period of many years, this was accepted. Investors now seem to be demanding that they understand what they invest in and are less willing to take an investment risk based on a track record or a trader’s previous experience.
Like every investment-based industry, there is tremendous diversification within the world of hedge funds. Different funds and different strategies offer different risk return characteristics which the investor should make sure they understand before making an investment decision.
The consensus seems to be that while in the past investors may have invested on the basis of track record, they will now demand to know more about all levels of the fund before they invest. This might involve investigating the background of principles and employees, interviewing the manager and examining his portfolio over a period of time, seeing how in-house risk systems and paper flows work and using professionals to examine the fund structure and set up from a legal and tax perspective.
So where are we now in terms of our threat to the global financial market place? Six months after the LTCM bail out, the articles on hedge funds are tucked back again deep into the financial press and read ‘White House says LTCM’s woes good lesson for markets’ ‘LTCM up 20 per cent, may return cash to bail out banks’ and, for those who might need closure, on Reuters, dated February 19 ‘Hedge Funds Return to Normalcy’.
The industry is showing no signs of shrinking. According to Nicola Meaden at TASS, the hedge fund industry has USD$325 billion under management across 5,000 funds with 90 per cent of those assets in 2,000 funds. If one looks at hedge funds on risk adjusted basis since the beginning of this decade they have produced the same returns as the S&P 500 (+ 15 per cent) with less than half the volatility (5.91 versus 13.50 for the S&P). |
Gilad Hayeem is director of marketing at Kyte Fund Management.
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