Hedge funds seen driving volatility
Managers cited for war rally and decline
By Beth Healy, Globe Staff, 3/27/2003
f you want to know what's driving the market's war-related volatility, it has less to do with mood swings of ordinary investors than with the rising clout of a small but powerful group of hedge fund managers.
Many investment strategists suspect hedge funds were the chief drivers of the prewar rally that pushed stocks up 10 percent in the nine days before the US invasion of Iraq. That the market turned upward so dramatically, when most mutual funds and hedge funds had been positioned conservatively ahead of the rally, showed signs of agile traders bailing out of short positions, or bets that stocks would fall, according to people who track hedge funds. And when stocks plunged on Friday, hedge funds were among the sellers, pocketing profits after the historic surge, analysts say.
Mutual funds, by contrast, made almost no dramatic shifts in their holdings as the war got underway; most say they've adhered to long-term strategies and selective stockpicking.
Christopher Conkey, chief investment officer for equities at Evergreen Investments in Boston, which oversees $52 billion in stock funds, said he believes the firm has done a good job of locking in gains and protecting its funds from potential losses in recent days, mostly by avoiding any big bets on risky stocks or sectors.
''The rise of hedge funds is a key factor in our world,'' Conkey said. Not only are they huge traders, he noted, but, ''Hedge funds' capacity to short stocks is enormous.''
In these volatile times, hedge funds are making hay of their ability to trade ferociously and place giant bets on stocks falling or rising. They're unfettered by the regulations that force mutual funds to stick to plain-vanilla stocks or bonds and to stay fully exposed even when they'd rather move into cash to dodge market losses. Worst of all, mutual fund managers gripe, hedge funds have the muscle to move the market and to command solicitous service from Wall Street brokers.
Hedge funds tend to thrive in down markets, and the best ones have done so throughout this bear market, while most mutual funds have fallen from heroic status in the late 1990s to double-digit losers since 2000. The average hedge fund posted a 5.8 percent profit in 2001, while the average stock fund lost 12.6 percent, according to Van Hedge Fund Advisors International Inc., a Nashville research group. Last year, when hedge funds recorded their first broad losses in 14 years, their 0.4 percent average decline looked rosy next to the 20.3 percent dive in the average stock fund.
''Even if a mutual fund manager wanted to be somewhat defensive and wanted to go more into cash, they can't,'' said John Van of Van Hedge Fund Advisors. Hedge funds, by contrast, are ''absolute return vehicles,'' meaning they're paid to read the market and make moves accordingly.
By living up to their name and mitigating market risk, hedge funds have surged in popularity these past few years and largely quieted the critics who emerged after the near collapse in 1998 of New York's Long-Term Capital Management, which made a giant, ill-fated bond bet. The industry now manages $600 billion globally, up from $311 billion in 1998 and $172 billion a decade ago. A good deal of the money flew into the portfolios while the market was soaring, but investors in the top funds have reaped the greatest benefits by sticking with hedge funds while other sectors have flopped.
Wall Street has not missed this money trail. The big-name brokerage firms consider hedge funds important customers. They handle trades for them, sell research to them - at a time when mutual funds are buying less Wall Street analysis - and, most lucratively, lend securities to them when they make aggressive wagers on a stock rising or falling.
To be sure, big mutual fund firms like Fidelity Investments and Putnam Investments get their calls returned on Wall Street. And the mainstream fund business, with $6.3 trillion in assets, still dwarfs the hedge fund universe. But hedge funds are seen as a massive growth arena, while mutual fund growth has stagnated. New York brokerage Merrill Lynch & Co. in December launched a host of new services for hedge funds and in its annual report cited derivatives and so-called prime brokerage services (including margin accounts and securities lending) strategic areas going forward.
Roger Kafker, a Managing Director at TA Associates, a Boston venture firm that last year invested $110 million in a New York hedge fund, the Clinton Group, said, ''The hedge fund business has a lot of years of high growth in front of it. If you look at it compared with the mutual fund business, it's still tiny.''
Clinton is bond-focused; its assets have surged to $9.8 billion from $5.8 billion in the past year. Some large Boston-based hedge funds include Bain Capital's Brookside Capital Partners, which has about $3 billion in assets, up from $2 billion a year ago; and Highfields Capital Management, an activist manager that runs about $3 billion, including money for the Harvard University endowment. Tudor Investment Corp. is a large player that houses its equity traders and research group in Boston; K Capital Partners and Par Capital Management also are based here, along with scores of smaller firms. And Red Sox owner John Henry is perhaps Boston's best-known hedge fund manager, having made his fortune at his Florida investment firm.
Add them all up and local hedge funds are nowhere near the size of Fidelity's biggest mutual fund, Magellan. Nationally, the average hedge fund has about $100 million in assets, which would be considered small for a mutual fund.
Bing Liang, a professor at Case Western Reserve University's Weatherhead School of Management who has studied hedge funds, said, ''Because of the different regulatory nature, hedge funds will have more arms and legs to kick, to punch. That would raise some concerns among mutual fund executives.'' |
