Echoing Kochis, Joseph acknowledges that the image of hedge funds painted in the popular press, generating triple-digit returns with huge leverage one year and getting slamdunked by that same leverage and a shift in the winds of the market the next year, is often at odds with the reality of the business. "Most institutions won't go near a fund that is up a lot more than 20% in any given year," he says.
Financial markets are in a continual state of flux, so it's not surprising that different styles or strategies move in and out of favor. The hottest strategy at the moment is Japanese long/short equity, largely because regulators in Japan just began to permit short sales of stocks.
Last year as the economy emerged from a recession, the fixed-income arbitrage arena produced robust returns. "All the accounting scandals of 2002 widened credit spreads, took a lot of bonds down and created many opportunities," says Cynthia Nicoll, senior vice president of investment management at Tremont Investments, adding that market evolution has also enhanced opportunities. "Today there is more of a tradable repo market and a deeper defaulted credit market." But she also cautions that we are now in "a different point in the cycle than we were a year ago," so opportunities could be moving elsewhere.
Lastly, there is the regulatory landscape. Two years ago, the subject of increased regulation of hedge funds was among the hottest in Washington. Then came the accounting scandals followed by the mutual fund scandals, in which a handful of hedge funds played a central role.
The mutual fund scandal may have moved the issue of hedge fund regulation to the back burner, but that's likely to be temporary. "The issue of what is appropriate transparency will resurface later this year," predicts Nicoll. If new regulations increase transparency, she and others suspect it will bring a lot of new money into the business.