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Investment view

It is little wonder markets were nervous last week as company results and economic statistics poured out of the US. The signs were mixed, to say the least. The prospect of slowing economic growth and rising inflation remains a possibility, even if stagflation of a virulent kind appears unlikely.

With investors understandably remaining nervous over the prospects for equity markets worldwide, what better time could there be to look at other asset classes? Coincidentally, the bond and hedge fund arenas came together rather neatly at lunch with an ex-colleague of mine. From being involved in the gilt-edged market for one of the leading UK banks, he now finds himself an adviser to a fund of hedge funds. His views on how he invests his own money were most interesting.

Surprisingly for someone who spent much of his City career in fixed-interest markets, he felt disinclined to buy bonds although they have been outperforming equities since the end of the 1990s. Indeed, while researching an article on global bond funds, I was impressed at the returns some managers have achieved. This is meant to be the less volatile end of the asset spectrum although things have changed over the years.

The reality is that bonds are now subject to greater price swings than used to be the case. Whether it is because there are more operators in the market or a consequence of the actions of the debt-rating agencies, it is no longer just interest rates and inflation prospects which move bond prices. As I was to discover, the difference between the best and worst performing bond funds can be very significant.

Maybe this is why my lunch companion felt inclined to use hedge funds as the more stable part of his asset mix. In particular, market-neutral funds appeared to him a good way of taking the risk out of whether the stockmarket is in a bull or bear phase. In theory, all you need to do is decide which share will outperform another and the rest should be plain sailing.

Performance figures emerging from the hedge fund industry suggest it is not. Last week, a study from a French business school suggested the average fund of hedge funds delivered a return of just 1 per cent for the first quarter of 2005. With cash returning not much less, you are not receiving a sufficient return to justify the perceived risk being taken.

This study covered a whole range of hedge fund strategies, so there would have been opportunities to iron out the volatility of the overall market. It seemed the best returns came from areas where the risk element was greatest. Short-selling funds returned nearly per cent during the first quarter – a demonstration how sticky the stockmarket has become.

Perhaps the biggest problem is that hedge funds are experiencing a flood of new money, particularly from institutional investors. The diversification game is being played everywhere. The trouble is the more money chasing these types of investment, the less likely it is you will receive adequate returns.

Much the same could be said about property. At the same lunch, I was told that sportsmen with big disposable incomes were more likely to put their surplus cash in buy-to-let properties than trust it to the stockmarket. While such an approach may be understandable when you take into account the likely comfort zone from which these investors are operating, it does not remove risk and could potentially distort market returns. Perhaps there is a case for using these dark days to pick up ordinary shares after all.


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