One of the benefits of the investment trust structure is that the manager doesn’t have to worry about inflows and outflows as funds come in and out of fashion. Indeed, it was this very fact that was behind the launch of a raft of hedge funds, and funds of hedge funds, as listed investment companies in the early 2000s. But the financial crisis in 2008 turned this on its head, which leads us to ask, is a listed company really the right structure for a hedge fund, and indeed, the average investor?
At its peak in mid-2008, the listed hedge fund sector comprised more than £8 billion in assets, according to the Morningstar Investment Trust Hedge Fund Index. Today this is nearer £5 billion and the number of funds (at a share class level) has dropped by more than 40%. This year alone, we’ve seen a number of funds breach their discount control targets, triggering a continuation vote.
There are now just 23 funds in the sector, of which four are in the process of realising their assets and three more are asking shareholders to vote on the continuation of the company. So what’s happened to push them so out of favour?
Listed hedge funds are, in theory, a great way for the smaller investor to gain access to larger, institutional hedge funds that would otherwise be out of their reach. It’s common to see the listed fund act as a direct feed into these larger funds—BH Macro (BHMG) is one such example. The listed fund invests exclusively in the Brevan Howard Master Fund, which itself invests in the Brevan Howard range of hedge funds.
The problems hit the sector when markets plummeted in 2008. While the funds themselves couldn’t be hit with a wave of withdrawals, given their fixed asset base, it didn’t stop investors from trying to sell out of the underlying master funds. This then impacted the net asset value (NAV) of the listed funds; the discount of the Morningstar Investment Trust Hedge Fund Index widened out to more than 30% by year-end that year, having started 2008 at a modest premium.
It’s fair to say that listed hedge funds have struggled to bounce back from this low. Even now, the index stands at a discount of more than 10%; that trend has been in place throughout this year and discounts even started to edge wider towards the end of 2011. Listed hedge funds generally haven’t delivered the returns that were common in the years preceding the financial crisis and investors have simply lost faith.
That’s not to say that all surviving funds should be avoided—after all, there’s an element of survival of the fittest. Indeed, funds managed by houses such as Brevan Howard and BlueCrest are trading at very tight discounts, or even a modest premium, suggesting there is much less concern with these funds. (The BlueCrest AllBlue Fund (BABS) is one good example of a fund where investors are paying a premium.) So there’s hope yet for listed hedge funds and their use of the listed company structure isn’t completely flawed but it’s a perilous path that needs very careful consideration.
Hedge funds and private equity are generally reserved for institutional investors, however, both investments can be accessed by individuals through the investment trust structure. For more information about accessing the private equity market, read Private Equity for the Rest of Us.
