How Australian Hedge Funds Take Advantage of Market Inefficiencies To Generate Out-Sized Returns

Hedge funds generally are able to generate out-sized returns from exploiting market inefficiencies and I would say that developed markets usually offer less of these inefficiencies than what can be found in less well research markets like Australia.

The advantage of investing in Australia is that while it is a developed market it only makes up about 1% of the global market which means that the majority of larger hedge funds don’t devote a lot of their resources to Australian investments. This leaves local Australian hedge funds in a very good position to exploit local market inefficiencies as there is less competition for these opportunities from offshore managers.

As a result the BlackPearl Masters Fund generally invests in many of the Australia’s local hedge fund managers which if discovered by international investors, by all standards, would be considered Blue Chip. However because they are located in Australia and don’t have the same brand names as some of the more well-known managers in Europe or the US they tend to stay below the radar of the broader global investment community simply because of where they are domiciled.

These managers have all the criteria that you would expect to see in a Blue Chip hedge fund such as:

  • Proven investment strategies including long/short variable beta, market neutral and global macro
  • Strong risk management capabilities including proprietary as well the latest in risk management software that tracks hundreds of risk parameters in real time
  • Quality infrastructure and service providers including custodians and prime brokers such as JP Morgan, Morgan Stanley, UBS, Citi and Credit Suisse as well as auditors Ernst and Young and PriceWaterhouseCoopers
  • Excellent track records comprising consistent track records that demonstrate the ability to generate significant alpha. For example our best performing hedge fund manager has generated a return of 8,388% since inception in 2004 which equates to 36.82% p.a. net of all fees and now manages around $1.6 billion. There are only a few managers globally that would come even remotely close to these performance numbers over the same period.

In addition from our experience we have found that some brand name hedge fund managers get to big and as a result are not able to move their portfolios around. These managers can become too comfortable from their management fees to want to take any significant risk. Unfortunately without any risk taking there can only be market returns rather than skilled based returns. This means that many of these managers end up taking more and more equity market risk under the disguise of long short strategies.

‘This leaves local Australian hedge funds in a very good position to exploit local market inefficiencies as there is less competition for these opportunities”

While some could argue that investing with large offshore global brand name managers is less risky we think that in some cases it can be the exact opposite. By being exposed to significant market risk an investor can end up paying high fees for beta. This can also leave the investor exposed to the exact risks that they were wanting to avoid.

As a result our strategy is and always will be to invest in hedge fund managers that are purely focused on alpha rather than gathering more assets. When such hedge funds are grouped together correctly we find that we can build a portfolio with very favorable risk reward characteristics.