More Investors Plant Cash in Hedge Funds - 02/04/04

NEW YORK -- The hedge fund industry continues to cash in on the positive buzz it generated by posting positive returns in the three-year stock swoon.

After suffering steep losses in stocks and mutual funds in the bear market, investors seeking steadier returns and protection in down markets dramatically increased their exposure to hedge funds last year. Unlike traditional mutual funds, hedge funds use strategies designed to post winning returns in all market environments. While mutual funds are restricted by their stated investment objectives, hedge funds have the freedom to move among all types of investments.

Global hedge fund assets swelled to an estimated $750 billion in 2003, up 25% from 2002, says Tremont Capital Management, a hedge fund consultant. Assets could top $850 billion in 2004, industry experts say.

Lightly regulated investment pools that once catered mainly to the wealthy, hedge funds are emerging as a mainstream investment, thanks to new products with minimums as low as $25,000. There were an estimated 8,000 hedge funds at the end of 2003, more than twice as many as five years ago, says Van Hedge Fund Advisors.

Driving that surge:

* Greater acceptance from institutional investors. In an effort to better diversify, big investors with huge asset bases are embracing such alternatives as hedge funds. Harvard University's endowment has 12% of its assets in hedge funds. Similarly, Calpers, the nation's largest public pension fund, has $1 billion allocated to hedge funds and is considering increasing that exposure. ''They view hedge funds as downside insurance,'' says George Van, chairman of Van Hedge Fund Advisors.

* Consistent performance. Since 1987, the Hennessee Hedge Fund Index has suffered one losing year.

* Lack of alternatives. With yields on bonds and cash miniscule, investors are seeking the potential for higher return, says Philippe Bonnefoy, who advises alternative investment strategies at Commerzbank Securities. Investors who enjoyed solid stock returns for the first time in four years in 2003 have been shifting money to hedge funds in anticipation of the next decline.

Hedge funds employ an array of exotic trading techniques, including short selling, which enables them to profit even when stock prices are falling.

That paid off in 2000, 2001 and 2002, when the CSFB/Tremont Hedge Fund Index finished with single-digit gains each year, while the Standard & Poor's 500 index fell more than 10% each year. In 2003, the CSFB/Tremont index rose 15.4%, vs. the S&P's 26.4% rise. ''The bear market was a turning point,'' says Charles Gradante, CEO of Hennessee Group. The ability to avoid losses ''did more to propel the validity of hedge funds than anything else,'' he says.

The industry's image has been hurt by events ranging from fund implosions to rogue managers ripping off investors. Hedge funds also have a reputation for making huge, risky bets. Last year, the Securities and Exchange Commission investigated the industry and in September issued a report. Top recommendation: Require hedge funds to register as investment advisers, which would provide ongoing oversight.