These Hedges Have Some Thorns

Looking for big returns? You could be in for a surprise

With names such as Jaguar, Tiger, Thoroughbred, Condor, and Rebel, the point is clear: Hedge funds aim to break out of the pack and be bolder and nimbler than, say, an aging bull. And with the stock market seemingly stuck in a trading range and investors nervous about whether the bull will resume its run, many wealthy investors are turning to such funds.

Just how much money is flowing into the secretive, largely unregulated world of hedge funds is unclear. From $6 billion to $10 billion has poured in this year, estimates Lois Peltz, managing editor of MAR/Hedge, a newsletter that tracks the hedge-fund industry. Estimates of the total amount of money in hedge funds range from $175 billion to $262 billion in as many as 4,000 different funds. "We're getting mail from at least 15 new managers a week," says Charles J. Gradante of Hennessee Hedge Fund Advisory Group. "The industry is growing by about 33% in terms of new managers."

SOROS ASCENDANT. But just how beneficial are such funds proving to investors? In the first five months of 1998, some of the largest and best-known hedge funds have racked up impressive gains. According to MAR/Hedge, a number of funds under Soros Fund Management are handily beating the Standard & Poor's 500-stock index. Quota Fund, for example, had gained a hefty 26% as of May 29, vs. 12.4% for the S&P 500. Quota is a global macro fund, meaning that it tries to profit from changes in currencies and interest rates around the world by playing global macroeconomic trends. Soros' Quasar International Fund gained 25.3%. Meanwhile, Julian Robertson's Tiger fund was up 22.9%.

Clearly, big-money investors have visions of huge gains dancing in their heads. But dig a bit deeper, and returns aren't quite as impressive. Sure, all the hedge-fund managers focused on Europe beat the S&P 500 for the year ended on May 29, according to Hennessee. But an index of more than 300 hedge funds tracked by the firm shows that only Europe and technology hedge funds bested the S&P 500's gain. The other 19 fund styles tracked by Hennessee fell short of the mark--some by a wide margin. The high-yield sector, as well as market-neutral funds, which try to cancel out market exposure with offsetting long and short positions, underperformed the S&P 500 by about 10 percentage points.

The worst hedge-fund performers in this bull market shouldn't come as any surprise: short-sellers, down 3.9%. These funds did have their time in the sun, however, rising to become the top performer for the month of May, with a 9% gain. George P. Van of Van Hedge Funds Advisors International says the only year in the past five that such funds have made money was in 1994, when they gained 13.7%.

The big losers for May include Latin America funds, which are down 12.2%, followed by emerging-markets funds, which are down almost 9%. Russia funds were badly hit. Funds that invest in mortgage-backed securities, which have been plagued by prepayments, are also hurting. Hedge funds playing the dollar-yen relationship also hit some snags in early June.

Trying to profit from the turmoil in the world's currencies kept managers on their toes. Grossman Currency Fund was one that prospered, gaining 24.6% through June 30. A currency play that is gaining steam is for managers to short the ecu, the forerunner to the euro, and go long on sterling. "Interest rates in England are going up, so sterling is strengthening, and those managers feel that when the ecu converts to the euro, there will be a flight to quality," says Gradante.

VOLATILITY TEST. Taking a look at an index of hedge funds, the record over the past 10 years is not so hot, either. The Hennessee Hedge Fund Index of more than 300 hedge funds, which its founders say represents 50% or more of hedge-fund industry capital, has outperformed the S&P 500 in 6 of the past 11 years. For the past four years, the S&P has beat it handily.

A more volatile stock market will allow the new crop of hedge funds to prove just how nimble they can--or can't--be. In the process, investors may find harnessing the power of a hedge fund far more challenging than riding an aging bull.

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