Many advisors still aren't convinced they are the way to go
In the absence of any signs of a rebound in the stock market, advisors continue their search for alternatives to bonds, stocks and long-only mutual funds. Yet after three consecutive years of equity market losses, many advisors remain wary of the most hyped of these alternatives vehicles: hedge funds.
"There is a gimmick factor I'm worried about," says A. Todd Black, president of Dogwood Capital Management in Cumming, Ga. "Everybody wants to be perceived as being proactive and looking at other alternatives. In reality, we're trying to find a short-term fix."
Black says he is keeping an open mind about hedge funds and started investigating them for possible use in his firm four years ago. But he still doesn't like what he sees in the hedge fund market, even with the growing popularity of "funds of hedge funds" products that have been touted as a more palatable gateway into the market.
Among his chief concerns are the veil of secrecy under which hedge funds continue to operate and their relatively high expense ratios. Black feels there are reputable hedge funds out there, but he says it takes expertise and time-consuming due diligence to find them or, at the very least, understand how they invest.
"When it comes right down to it, I am in the people business and my energy is better used focusing on my clients," he says. "This is not a strategy that should be employed by inexperienced or unsophisticated investors, regardless of whether or not they are qualified."
Not that hedge funds haven't been making inroads in the advisor market and in the investment universe in general. Global hedge fund investments climbed to about $650 billion last year, up from about $480 billion in 1999, according to Van Hedge Fund Advisors International, a global hedge fund advisory firm. During that same time frame, the number of global hedge funds has grown from 6,200 to 7,500. Standard & Poor's has also announced plans to come out with a hedge fund index of its own.
Feeding the growth has been the expectation that these historically niche products can add market neutrality and stability to portfolios that have been eroded by a bear market in recent years. Hedge fund indexes certainly encourage that view. Since the start of the bear market in early 2000, the Van U.S. Hedge Fund Index has increased 2.6%, while the S&P 500 has dropped about 44%. The Hennessee Hedge Fund Index, meanwhile, was down 3.43% last year-its first negative year since it was created in 1987.
Some advisors have seen this type of performance reflected in their own portfolios. Andy Berg, a partner with Homrich & Berg, financial advisors in Atlanta, says his firm began work to build its own fund of hedge funds portfolio at the height of the bull market in 1999.
"We wanted to look for other ways to skin the cat, because we thought the market was materially overvalued," Berg says. "We wanted other ways to achieve an attractive return outside a long-only stock position."
Building its hedge fund portfolio with funds using market-neutral, long-short strategies, the firm has averaged about a 12% gain per year since it was started, he says. The fund of funds represents between 15% and 20% of most of the firm's clients, he adds.