eFinancialCareers

High risks and high rewards for the lucky few.

Hedge fund managers are the maverick outsiders in the financial services world. Most are highly successful former traders or fund managers who have decided to go it alone.

The name 'hedge fund' comes from the idea that money managers can hedge their bets to ensure they make money – whether the market goes up or down. For example, a fund that invests in shares of company X risks losing out if the share price falls. To offset this risk, it might buy an 'option' giving it the right to purchase a particular quantity of company X shares for a particular price, at a particular point in the future.

If the option to buy is set at a low enough price, the fund will profit, even if the share price has fallen – it can buy the shares at below the market price and sell them on again, thereby recovering the losses on its initial investment.

In reality, hedge funds aren’t the only members of the financial services community to indulge in hedging – banks do it every day. What distinguishes a hedge fund from a traditional fund manager is the willingness to push the boundaries of normal investment techniques to achieve unusually high returns.

Most hedge funds follow a particular investment strategy. The most popular strategies are:

1) Short selling: A short seller borrows stocks that they believe are overvalued and sells them on. When the price (hopefully) falls, they buy the stocks back at a lower price and return them to the lender.

2) Global macro: Global macro funds operate a strategy similar to that used by short sellers. But they focus on global trends, rather than movements in particular stocks.

3) Event driven: Event-driven funds try to profit from one-off events, such as mergers and acquisitions or bankruptcies. For example, if one company decides to buy another, it will usually offer to pay more than the current market price for the shares.

Because hedge funds are considered risky, investors can also put their money into 'funds of hedge funds'. These invest money across several different hedge funds, with the intention of spreading the risk.

Some funds also like to describe themselves as 'absolute return funds'. This highlights their goal in always making a good return for investors, rather than just losing less money than other funds in a poor market.

Trends

Hedge funds are rarely out of the news in international markets. Whether it’s a question of the immense amounts of money made by their founders or fears that they are liable to topple the entire global financial system, they make good copy. During the past few years, the hedge fund industry has enjoyed a period of impressive growth. According to HedgeFund Intelligence, a research company, hedge funds had around US$1.5 trillion in assets globally at the start of 2006. This was up from US$400bn in 2000.

Hedge funds have had a turbulent history. One of the most famous highs in the history of hedge funds came in 1992, when the Quantum Fund, run by international financier George Soros, helped force sterling out of the European Exchange Rate Mechanism. One of the most famous downs was in 1998, when hedge fund Long-Term Capital Management, a fund with US$120bn under management, nearly collapsed after making bad bets during the Russian currency crisis.

Australia has emerged as a key centre for hedge funds in the Asia-Pacific region, overtaking Singapore, Hong Kong and Tokyo as the preferred base for hedge fund firms. According to the Reserve Bank of Australia (RBA), the amount of money invested through hedge funds grew three-fold from AU$20bn in 2003 to AU$60bn in 2006.

Interestingly, while the majority of money invested in hedge funds globally comes from institutional investors, two thirds of the money invested in Australian-based hedge funds comes from high net worth individual and retail investors.

However, institutional investors have also increased their allocation to hedge funds from an average of 2% to 6% over recent years, and this trend is expected to grow.

The RBA says there are now more than 200 hedge funds based in Australia. As more of them crowd the market and use similar investment techniques, volatility in their returns has also reduced. They are seen by investors as much as a defensive strategy in uncertain times as a get-rich-quick investment.

Key players

Most hedge funds are created by fund managers who decide to start their own business. The biggest hedge fund investor in Australia by a big margin is Platinum Capital, which has some AU$20bn under management, almost exclusively from retail investors. It was founded by Kerr Neilson and other former employees of Bankers Trust Australia in 1994.

Other major players include PM Capital, Grinham Managed Funds, Portfolio Partners, Artesian Capital Management, Basis Funds Capital Management, and MQ Capital Management, a unit of Australia’s biggest investment bank Macquarie Bank.

There are numerous smaller funds being created every month. However, watch out – some newly formed hedge funds close down as quickly as they start up.

Roles and career paths

Jobs in hedge funds tend to fall into four categories:

1) Analysis – analysing the companies, markets and financial products a hedge fund invests in.

2) Sales and marketing – liaising with investors and helping sell the merits of the fund.

3) Trading – executing the investment strategy, and buying and selling financial products according to analysts’ recommendations.

4) Risk management and back office – settling trades, working out a hedge fund’s risk exposure and making sure everything flows smoothly. In many small funds this is outsourced to 'prime brokerage' divisions in investment banks.

Most roles are distinct: if you join as a risk manager, the chances of graduating to become an analyst are slim. However, it’s not unknown for analysts to become traders.

The bad news is that as a new graduate, you will be very lucky to walk into a hedge fund. Most are small organisations without the time or resources to train graduates themselves. Instead, they recruit people with a few years’ experience from investment banks.

Pay

If you’re interested in working for a hedge fund, you probably know that they have made some people very rich. According to Alpha magazine, the best paid hedge fund manager in 2005 was Edward Lampert, who runs Connecticut-based ESL Investments. He made US$1bn.

If you join as a lowly analyst or marketing person, you won’t be quite in that league. Nevertheless, you’ll probably be wealthy compared to most other people you know. Salaries for analysts vary sharply, according to recruiters, from about AU$60k to AU$100k, but bonuses can treble that number and many hedge funds encourage equity ownership in the fund, which can create significant dividend payments in a successful year.

Skills

• Jeremy Reid, managing director of Everest Babcock & Brown, a Sydney-based fund of hedge funds manager, says the key attributes for the industry are flexibility and an enquiring mind. “The industry is fast moving and hedge funds are often at the forefront in the development of new investment structures, techniques and strategies. As such, it is imperative that our staff stay abreast of the latest innovations in the industry so that we can maintain our competitive edge.”

• Tom Elliott, the co-founder and head of Melbourne-based special events fund MM&E Capital, says he tends to look for people with a “reasonable degree” from university and a track record of investing their own money. “You need someone with internal drive and an ability to learn from others and not someone who is convinced, as many graduates are, that they already know all the answers.”

• Kim Ivey, founder of Sydney-based hedge fund Vertex Capital and chairman of the local chapter of the Alternative Investment Management Association, says most hedge funds are looking for generalist skills across all markets. “My advice is to go to a large investment bank or diversified institution and absorb as much information and gain as many skills as you can across many markets.”