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September 30, 2003

Hedgies for the Pros

By Kathryn M.Welling

Think about it. If you were okay in 1995 and the market then went up 300 percent and then fell back down, you'd think you'd be more or less back where you started. But somehow something got messed up on the way down, right?

Big time.

While companies feasted on "earnings" that should have been poured into the pension plans. Which, of course, had a negative impact on the net present value of the pension plans.

Anyway, institutional investors are stampeding into funds, like yours, that promise things like low volatility and non-correlation with the indices. Yet isn't volatility what most often creates opportunities in the markets?

It depends on how you define volatility. We define it as the annual standard deviation of returns. But there are clearly other ways of looking at it. That's why funds of funds are popular, isn't it? Maybe, if you have a little of everything, you get the best of all of it.

Or the worst.

That is true.

What's that line about lies, damned lies and statistics? The irony is most hedgies's returns lately have been uninspiring.

True, the median return last year was negative for the hedge funds tracked by Tremont and HFR, which are universes that include long-short, market-neutral, commodities, just about every style.

Not exactly a strong selling point.

You're right. We use HFR's indexes for comparison. We are biased towards them but they do a pretty good job of keeping the index clean and they do have a long history. Part of the trouble is that the really terrific hedge funds don't report results anymore. They just don't want to hassle with it. They have enough money.

Even so, what numbers are available suggest that many of the investors who've poured into hedge funds in the last couple of years must be disappointed.

Yes, people have been disappointed for the last two years. But you have to put that into context. Last year, Avera Global Partners was down about two percent. It was our first year. And a two percent decline was pretty much the average for all of the managers in our category. But meanwhile, the market was down 19-20 percent.

Admit it, haven't you looked at your own results sometimes and wished you'd had the nerve to jettison the losing short side of your portfolio? Without it, you'd be up something like 25 percent year-to-date.

Great question. Think about it this way: If you are really a stock picker, why not just create a 10-stock portfolio, five longs, five shorts? That is extreme, I admit, and I don't know anyone who does it. But with that portfolio, I really wouldn't care what the market was doing. I'd just want to find the stocks that were blowing up in a bull market and the ones that were beating the numbers in a bear market. In a sense, that is what we do.

How so?