The rise of GARS

Hedge funds are being pushed out of the alternative asset space

Before 2007, hedge funds raised capital at their discretion. Yet the recession has exposed many funds which appear to have raised returns in the good years by increasing risk rather than by generating the ‘alpha’, i.e. above market returns with the same or less risk, which their glossy marketing brochures purported.

Still, the investment industry is nothing if not adaptable. While the profile of hedge funds may be plummeting, its less racy cousin, the absolute return fund, continues to grow in popularity. Standard Life, a leader in this area, has seen investors scrambling to enter their alternative asset fund known as GARS.

While finance may not have lost its taste for opaque acronyms, institutional investors may be losing their appetite for risk; GARS, which stands for Global Absolute Returns Strategy, claims to offer more consistent and modest returns than its hedge fund competitors. (Though one wouldn’t necessarily infer that from the title).

The rise of absolute return investing presents hedge fund bosses with a headache. Institutional investors have historically looked to hedge funds to provide diversification and a little extra return on the market index. Yet while a few hedge funds recognised and profited from the housing bust and subsequent recession, most missed it and found themselves unable to live up to their alpha aspirations, or even match the benchmark. The few who did profit in the downturn have often proved themselves one trick ponies, incapable of repeating good performance. Consider Paulson & Co.’s miserable returns since the fund made a nice profit shorting bad mortgages.

All this has left institutional investors sceptical if not openly hostile to the prospect of investing in hedge funds; something the more traditional investment management companies have looked to capitalise on. Whereas hedge funds are often distinct entities, absolute return funds can quickly be thrown together in house under the auspices of ‘alternative strategies’. This has resulted in the proliferation of funds from the traditional investment firms looking to get involved in this high fee area. Both Schroder’s and Investec offer rival absolute return funds which match Standard life’s GARS fund both in investment strategy and the absurdity of the funds’ names, the dynamic diversified growth (DDG) fund and the global tactical asset allocation (GTAA) fund respectively.

While the naming of such funds leaves something to be desired, investors have been flocking to them in droves. Some of the main benefits of these funds have been the decent returns, low correlation to equity markets and, and this really sticks in the throat of hedge fund managers, lower fees. Whereas hedge funds typically charge 2 & 20, that is a base fee of 2% of assets regardless of performance and 20% of any returns above the benchmark, Standard Life’s GARS fund charges a flat fee of 0.5%

Investors seem to be waking up to the reality that hedge funds, while at an individual level may outperform the market, have collectively failed to match their respective benchmarks. Investors have been coaxed into investing in such funds by promises of alpha, dud investment consultants and arbitrary performance reporting, and non-reporting for that matter.

Absolute return funds seek to provide investors with equity like returns without the associated risk; yet as something similar was previously promised by the hedge fund industry, investors shouldn’t hold their breath.