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MARKET COMMENT
By
Man Group (LSE: EMG), the hedge fund manager, has been one of the best performing shares in FTSE 100 over the past two years. Formerly known as ED&F Man it floated in October 1994 at 180p. The shares doubled over the next six years but towards the back end of 2000 the company's alternative investment focus suddenly became all the rage. The shares trebled in the next 12 months although they have slipped back a little in the last few months. Today the company produced a 19% rise in profits to £213m as well as announcing the £570m purchase of the Swiss hedge fund group, RMF. Funds under management soared from £4.6b to £7.4b. Man reckons some £400b is invested in alternative investments worldwide. However, although ongoing net management fees rose by two-thirds to £118m, Man actually saw the performance element of its net income fall by 27% to £55m. Brokerage fees increased by 27% to £38m. Hedge funds are still largely misunderstood as investment vehicles. Their basic strategy is to place bets that should make steady gains whatever the stock market weather. Say the manager thinks that the value of mobile telecom shares are out of kilter. He or she might buy shares in Vodafone (LSE: VOD) whilst shorting mm02 (LSE: OOM) (i.e. betting that the price will fall). In essence he or she is betting that the valuations of the companies will converge. If the general market falls the idea is that losses on the Vodafone trade will be offset by gains in mm02 and vice versa if the market rises. Of course the danger is that the prices will not converge. If the gap continues to widen then the strategy will backfire, especially as hedge funds often gear their investments to magnify the effect of any gains. This is essentially what caused the downfall of Long Term Capital Management. That's the theory anyway. As hedge funds are now flavour of the month, many investment funds have called themselves hedge funds when in fact they do not fit even the loosest interpretation of the traditional definition of the term. They are often making large one-sided bets on the market and becoming croppers after their beginner's luck runs out. The overall performance statistics of hedge funds are much questioned, due to the large number of them they go belly up and get missed off many of the performance tables. As for Man Group, last year's pre-tax profit of £213m represents 3.5% of its average funds under management. Compare this to the 0.5% or less you pay for a common garden tracker. At £2.5b its market value is a colossal one-third of its current funds under management. Hedge fund fans will point out that good performance can justify these fees but the fact remains that one person's outperformance is another's underperformance. There are only a finite amount of gains to be made from the world's assets. Hedge funds do not create new wealth they only redistribute what is there anyway. However, if you fancy an investment based on people's gullibility then perhaps Man Group is just the ticket.