Managers and analysts are now unearthing value in an asset class that just six months ago hit rock bottom and witnessed an exodus of investors: funds of hedge funds.
The double whammy of hedge funds deleveraging and the Madoff scandal saw investors flee listed hedge funds at the end of last year, pushing the discounts to their underlying net asset values above 40 per cent.
The total UK hedge fund sector was worth more than £8bn at the start of the year but some £1bn has since been returned to investors.
However, this flight of private client brokers and wealth managers has left shares in funds of hedge funds still trading at a wide discount to the underlying net asset value (NAV), opening up opportunities for so-called discount players.
One of these discount players is James Carthew, who manages the Advance UK investment trust, a fund of funds that looks for investment trusts on wide discounts and then tries to put pressure on the board to narrow them.
“Almost every fund out there is on too wide a discount,” he says. “We’ll eventually get down to a core of people who genuinely want to hold these things and then discounts will narrow.”
He has bought shares in GS Dynamic, Dexion Absolute and Thames River Hedge Plus.
Many funds of hedge funds could still disappear, if the boards fail to sort out the discounts and if the underlying portfolios are very illiquid.
But again, this could present a buying opportunity.
“Some of them might be quite attractive opportunities if you play the potential for wind up,” notes Carthew. One such fund in his portfolio is Gottex Market Neutral.
Simon Elliott at Wins Investment Trusts thinks the fundamental factor when assessing funds of hedge funds is the NAV performance. Often, discounts reflect investor sentiment only – and not the performance of the underlying assets, he argues. Dexion Absolute, for example, has seen its NAV rise 15 per cent this year but is still trading at a 24 per cent discount.
Investors should also watch further tender offers and redemptions in the pipeline, which could act as a catalyst for discounts to narrow, says Elliott. FRM Credit Alpha said this month that its tender offer was heavily oversubscribed.
Ewan Lovett-Turner at Numis Securities says investors should look for funds with both liquid underlying portfolios and liquid shares – that is, larger funds such as Dexion Absolute.
If the underlying portfolio is not liquid, this does not bode well for the company’s ability to return capital to shareholders if it winds up.
Many of the hedge funds that funds invest in imposed lock-in periods on redemptions last year – meaning that, even if a fund did try to wind up, it might take some time for investors to get their money back.
Lovett-Turner likes Alternative Investment Strategies, which invests mostly in hedge funds with monthly redemption terms. He says CMA Global Hedge, in contrast, has suffered from being invested in illiquid funds and that there are questions over how long it will take for it to return capital to shareholders.
Investors are urged to check the underlying assets in a fund of hedge funds before buying. Before last year, this would have been a near-impossible task. However, many companies are making more of an effort to explain to investors what their holdings are, says Lovett-Turner, with explanations on their monthly factsheets on how long it would take for investors to get their money back.
Funds of hedge funds used to be aimed at people who wanted a steady monthly return without too much volatility, says Mick Gilligan at Killik & Co. Now they are better suited to investors who want to take advantage of the discount.
