Hailed by many as alternate investing and hedge funds guru, Morgan Stark, managing member, Ramius Capital, is widely recognised for his aptitude in selecting funds and fund managers. In Oman to review the Darren Multi Strategy Fund that his company manages through Fincorp, Stark shares his views on the growing market for alternate investment funds.

What is the spirit of hedge funds?

One way to define it would be - investment pools for the wealthy who may take risks by using leverage, or borrowed money, to amplify returns. However, the spirit of hedge funds is to group unregulated pools, generally with fewer than 100 investors who invest in both asset class and derivative securities and use long and short positions as well as leverage.

Where are hedge funds placed in the universe of alternative investments?

Alternative investments can be divided into illiquid and marketable. Illiquid alternatives are long-term locked-up funds like real estate, private equity, venture capital and natural resources: timber and oil and gas. Hedge funds come under the marketable alternatives, being further structured as opportunistic or those based on absolute returns. The sole factor for hedge funds to be classified under marketable alternatives is their very nature of being liquid.

What is the investment philosophy at Ramius?

As an investment management firm pursuing low-volatile 'absolute returns' that are also 'non-market-directional' in nature, the firm's expertise lies in allocation and management of a diverse series of strategies within various programmes. We provide net annualised returns of 5-10 per cent above the risk-free rate of the 91-day US treasury bills over a complete market cycle with minimal volatility compared to the historical return pattern of traditional asset classes such as equities and bonds.

The firm's goal is to provide its investors the benefits of a stable long-term compounding of capital while receiving highest possible levels of client service. We manage approximately US$7.5bn of assets. Portfolios are managed with minimal leverage, making return targets more dependent on particular strategies as well as the skill of the portfolio manager.

What do you look for while selecting funds and hedge fund managers?

We look for hedge fund managers who can convince us they have an edge. Once we understand why one fund manager has an edge over the others - be it through access to superior research or information flow, better analytical skills, intelligence or contacts - we can understand why that person is likely to outperform his/her peers.

Understanding the qualitative factors that differentiate successful hedge fund managers eliminates, to a large extent, the need to see long-performance records. Many times I've heard of investors who will not consider a new manager unless he has a long track record. I do not agree with this approach. I would have missed some of our best-performing fund managers if I'd waited for long performance records. Many a time, the most successful fund managers attract large assets so that by the time they have a five-year track record they are no longer able to produce the outstanding returns they enjoyed managing a smaller asset base. Moreover, research indicate that hedge fund managers tend to have their best returns during the initial years of running their funds.

What do you do when a fund is delivering poor results?

It hurts me more when my investors and friends lose money. I have a low tolerance for continued poor performance. If any fund manager starts delivering poor results without a really good explanation, it's time to get out.

What red flags do you look for before withdrawing investments in a fund?

One indicator is when the manager deviates from his agreed strategies and objectives. One of the funds we had invested in deviated from their proven strategies and had a bad year in the process. A major part of the money they had under management was withdrawn. We immediately cut back half of our investment. After subsequent in-depth discussions with the manager, who undertook to return to his proven approach, we have reallocated funds, and the manager is once again doing well.

But even when changes occur for the better, if a manager cannot adequately explain why there was an uncharacteristic increase, it is a cause for concern. We watch out for managers taking on too much money. Returns may begin to drop or they may try additional strategies. Inconsistency is another cause for concern. If the feedback from our network differs from the messages we get from the fund manager, it's a red flag. Another indicator is when you come to know that other investors have begun redeeming their investments from a fund.

Can you elucidate the absolute returns strategy adopted by Ramius?

Returns derived from traditional asset classes such as equity, fixed income or currencies are highly dependent on market direction. Because of this, performance is measured relative to a specific market index or peer group of managers.

In contrast, numerous alternative asset class strategies focus on generating absolute returns, which are non-market-directional in nature, by exploiting inefficiencies in various financial market sectors.

It should be noted, however, that the potential for loss of principal is not eliminated. Pursuit of non-market-directional absolute returns forms the very foundation of Ramius Capital's investment approach. We also impose risk management disciplines to minimise the volatility of returns over each reporting period. Successful risk management techniques enhance the compounding effect of attractive annualised returns on investor capital, especially over the long-term.

In a nutshell, I can say that at Ramius Capital, we specialise in the low-volatile but absolute return space.

All About Hedging

• Hedge fund is a structure, not a strategy

• Not all hedge funds are the same

• Hedge funds are a growing sector of capital that is different from the traditional investment funds

Common Misconceptions

• All hedge funds generate huge returns or suffer huge losses

• All hedge funds are risky

• All hedge funds aggressively short stocks in order to profit from their demise

• All hedge funds use tremendous amount of leverage

Narayan Krishnamurthy

© businesstoday 2005

 

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