Hedge funds had a good year in 2002 -- relatively speaking.
By Stephen Taub
February 2003
Institutional Investor Magazine
The average fund’s 3.4 percent loss (as reported by Hennessee Group) easily bested the double-digit drops of the major stock indexes and the typical stock mutual fund’s 22.4 percent plunge.
The trouble is, hedge funds are not supposed to merely do better than other investments they’re meant to outperform in absolute terms. And that most did not do in 2002. Hedge funds, which now manage more than $600 billion, boast that they will make money in all market environments -- and, indeed, shine in falling markets. But last year many bet too heavily on stock prices rising.
“The market was really bad for everyone, including hedge funds,” points out Charles Gradante, managing principal at Hennessee. Moreover, overall returns were constrained by spectacular blowups at Beacon Hill Asset Management (shut down), Lipper & Co. (in liquidation) and Gotham Partners Management (still operating but with substantially reduced capital).
A raft of well-established names had disappointing showings. Among them: Morris Mark’s Mark Partners (32 percent); Raj Rajaratnam’s Galleon Omni Technology and Galleon Technology Offshore (26.6 and 19.3, respectively); Philip Hempleman’s Ardsley Offshore (24); Leon Cooperman’s Omega Overseas Partners (13); Arthur Samberg’s Pequot International (13); Richard Chilton’s Chilton International (11); and Joseph DiMenna’s Zweig-DiMenna (International 11).
But some managers were able to adroitly play megatrends: declining stocks, falling interest rates and a weakening dollar. Who were the big winners in 2002? Among the largest hedge funds, the top performers were macro managers who scoured the world’s markets for inefficiencies or bet heavily on trends.
John Henry of John W. Henry & Co. was up 45.2 percent (all returns here are net of fees) in his $256 million-in-assets JWH Financial and Metals Portfolio. Kenneth Tropin, Henry’s former No. 2, who since 1994 has run Graham Capital Management, oversees Graham Global Investment Fund K4, which jumped 43.7 percent.
Perennial stars Bruce Kovner and Paul Tudor Jones II again adoitly surfed macrotrends. Kovner’s Caxton Global Investment and Gamut funds rose 26.3 percent and 23 percent, respectively, while the Tudor BVI Global Fund jumped 21.2 percent.
With some variations in timing and allocation, all four investors played the same trends. Tropin says he got almost 19 percentage points of his nearly 44 percent gain from fixed-income futures, cashing in on the global decline in rates; an additional 15 or so percentage points from the foreign exchange market, especially during the dollar’s sharp decline against the euro last summer; a further 6 to 8 percentage points from shorting stock index futures in France, Germany and the U.S.; and the remainder from bullish plays on grains.
Henry made several like-minded investments. “We really took advantage of the downward trend of the dollar in many markets and in many ways,” says Ted Parkhill of Henry & Co.
Among the most successful short-sellers last year were the managers at Andor Capital, the $8 billion-plus hedge fund operation that broke off from Pequot Capital Management in late 2001. Last year Andor Dividend Growth, managed by David Feldman and Christopher James, was up 31.1 percent; while Andor Technology Small Cap, run by Daniel Benton, climbed 23 percent. “Benton shorted big,” says one knowledgeable observer.
A number of convertible arbitrage funds stood out. Alta Partners, a $680 million fund, was up 29.9 percent. Like most convertible arb managers, Alta goes long on the convertible and shorts the underlying stock. The firm takes the stratagem a step further, however, and short-sells a series of high-yield indexes as a hedge. “This provides us with a liquidity hedge,” explains Kevin Crouchley, Alta’s president.
In emerging-markets investing, Russian specialist William Browder’s Hermitage Fund bested all comers with a 33 percent gain. Of unused to portfolio figure calls for some perspective: Hermitage fell 92.9 percent in the 12 months ended October 1998 -- a reminder that with hedge funds, risk is never far away.
