December 31, 2006

The Devil or the Deep Sea? Multi-Strategy Funds or Fund of Funds?

-- By Pushpa Sathish, Staff Writer

Fund of hedge funds or multi-strategy hedge funds? Are the two similar or do they have their own advantages and disadvantages? Corbin Capital Partners, a New York-based hedge fund which runs a fund of funds but is owned by founders of one of the world’s biggest multi-strategy hedge funds, Highbridge Capital Management, offers an insight into these two investment strategies:

  • Both move in and out of various markets to maximize the returns and minimize the losses in each.
  • Multi-strategy funds returned more that fund of funds over the past few years because of lower fees and better strategic skills. But since the latter are less volatile, their performance has been better.
  • If multi-strategy funds are supposed to diversify and minimize risk, then why did Amaranth collapse? Because these funds use a technique known as cross-collateralization, where leverage is used across the whole firm and assets of all strategies are used to offset the risk. So if one strategy fails, it pulls down the rest like a house of cards.
  • Multi-strategy hedge funds tend to put more money on markets that are doing very well. This backfires when the trader handling the strategy demands more money – the fund faces a dilemma to accede or not, because it may be damned if it does and damned if it doesn’t. If it does shell out more money and the strategy backfires, well, you have another Amaranth on your hands. And if it doesn’t, the trader may very well walk out and start his own hedge fund.

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