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Investment View

Long-term followers of this column (assuming there are some) will know I consider myself open-minded and prepared to be converted on certain topics. Or partially converted, anyway. Take derivatives. From considering them to be highly dangerous, I have come round to the view that they are valuable – necessary even. What I still consider to be the case is that most investors do not understand them sufficiently well to venture into this market with any degree of certainty.

It is only by learning more about these instruments that I have overcome my prejudices. A cause for concern remains the way in which some investment management houses use derivatives to construct products that the average retail investor cannot fully understand.

I know we are close to the second anniversary of the demise of Long Term Capital Management – which came closer to bringing down the Western banking system than most people realise – but, by and large, hedge funds have appeared the province of the wealthy, experienced investor. I was surprised to learn, therefore, that there is an investment trust which invests in hedge funds. To be more precise, it is a closed-ended fund as, while it is listed in London, it is registered in Guernsey. The price, hardly surprisingly, is quoted in dollars. Alternative Investment Strategies is the name – appropriate given the way in which it invests.

A quick look at the share register and you will see that although this is a fund that can be bought by private investors, it is the institutions which so far have proved the biggest supporters. Two of them – Equitable Life and Co-operative Insurance Company – comfortably own more than half the shares between them.

The third-biggest shareholder is the private-client department of International Asset Management, which happens to be the company providing the management skills. I visited its West End offices recently and was amazed to find an investment house running very nearly $2bn-worth of client funds of which I have never heard before. All it does is manage portfolios of hedge funds – and does it very successfully. Alan Djanogly, one of the founders, ran me through its database of many thousands of hedge funds. This is research on a grand scale. It still stays close to the managers to keep abreast of change but its systems will demonstrate very quickly whether funds deliver in accordance with expectations, providing an early warning system for when things go wrong.

Its speciality is buying into so-called long/short funds. These are hedge funds that are technically market neutral. You may be long of some shares and short of others but you have no exposure to the market overall. In rising markets, this means you are likely to underperform the index – because of the cost of the hedge – but you should deliver positive returns when markets fall. The efficacy of this approach was demonstrated as Alan ran me through charts showing how good long/short hedge fund managers made considerable progress in falling markets. The cumulative effect of a fund always moving upwards was quite staggering.

Hedge funds are taking an increasing amount of wealthy investors&#39 money in the US and may well catch on here. But it remains a difficult market to understand and to access, with minimum investment levels high. However, almost daily you read of bright fund managers leaving traditional investment houses to set up their own hedge fund operation, so there is clearly momentum in this market. Perhaps more funds of hedge funds will emerge. Alternative Investment Strategies looks an interesting proposition but the shares are not an easy market and stand at a premium over underlying assets.


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