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Fund redemptions are nothing new. Every recession or bear market sees investors redeeming their fund investments and moving to asset classes which provide a greater degree of safety. For most, this is the Government Treasury Bill also called the T-Bill.

While reasons for redemptions are as varied as the investment selections themselves, it seems that individual investors are uncertain of their understanding of what their money has been invested in. While mutual funds are marketed to the investor with a lower knowledge of investment products, the hedge fund has always been the investment choice for more knowledgeable investors or the “Accredited Investor”. But now it seems even this group is calling for the need of greater understanding from their investment managers.

The battle for returns which out perform the index has resulted in many Portfolio Managers refusing to disclose their trading program for fear others will duplicate their trading style. It is said by many managers that it’s this ability to observe unique characteristics in the market place that differentiates their funds performance from the typical returns generated by bottom quartile performing funds and fund managers. Of course the unregulated hedge fund industry has perpetuated this myth by trusting the Accredited Investor with an above average knowledge of the market and his ability to select the correct investment for their portfolio. It seems the Accredited Investors does not always posses greater knowledge than their more un-sophisticated mutual fund brethren.

So that bears the question of how to obtain this transparency to the satisfaction of the investing public? And the answer is the Managed Account.

Managed Accounts are simply individual accounts opened in the name of the investor. These accounts are not pooled, yet they are identically structured and managed by the hedge fund Portfolio Manager in the same style as the pooled fund. The critical difference is the investors ability to see every trading transaction performed in the account by the fund manager.

The popularity of the pooled investment structure is that investors do not have to deposit large sums of money to utilize the services of a professional Portfolio Manager. Most successful professional Portfolio Managers do not accept accounts less than US$10 million dollars.

The hedge fund and mutual fund gained popularity by allowing smaller sums of money to be pooled with other deposits from many other investors. So while you can currently participate in a hedge fund investment for $100,000 and a mutual fund for $50., a managed account may require a minimum investment in excess of $1 million. Not so good for everybody.

But lets suppose you can convince your hedge fund manager to accept your $100,000 what advantage do you gain.

the investment account is actually in your name and not in the funds name;
your account is segregated from all other trading accounts;
instead of waiting for your monthly or quarterly statements, you can see the activity in your account on a daily basis in real time;
cash deposits or withdrawals can be simplified;
you have an overall increase of account transparency; and
you can no longer claim you did not know what was going on in your account. (oops, is that a benefit?).

There are also some disadvantages. Or put another way, the pooled investment structure provides some distinct advantages which originally made them popular since the first hedge fund was created in 1949. These funds should not be confused with the investment account managed by your stock broker. The professional Portfolio Manager will continue to exercise complete trading autonomy and does not want your advice on how to manage the assets in your account.

Advantages for remaining in a hedge fund or mutual fund:

investors can obtain the services of a professional fund manager with smaller sums of money;
management costs are cheaper since it is more economical to manage one large account instead of many smaller accounts;
you pay one flat management fee, no commissions; and best of all
you still have someone to blame if things go wrong.

It is estimated the hedge fund industry managed $2.7 trillion dollars by the end of 2008. The mutual fund industry manages $19 trillion investment dollars. So there is no question of the popularity of the industry since that first fund in 1949.

If transparency is an issue for you, you need to take a long, hard look and evaluate the pros and cons wisely. Take some time to speak with your fund manager about a managed account, it just might be the alternative you’ve been looking for.

Here are some of the excuses I hear from professional money managers and risk managers for not having a hedging program in place:

we’re waiting for more signals just to be sure;
I read an article which said the stock market has more upside;
we’ll make a decision after the next quarterly earnings are out;
I’ve been managing assets for 20 years and I’ll know when it’s time, and it’s not time yet;
I don’t want to leave profits on the table;
what’s hedging?

That last excuse always causes my heart to skip a beat. It’s troublesome because professional money and risk managers either have forgotten the basics of asset management or have never learned the principals of their profession.

I completely understand every other excuse and the reasoning behind them all. There’s just one problem and that problem has been around for as long as the economy itself. The reality of the situation is that almost everyone fails to see the signs in time to alter course. Or greed comes into play where the asset manager wants to squeeze every last percentage point of profit. No doubt street creds are valuable when marketing a funds return to potential investors. I get that too.

I’ve spoken to hundreds of risk managers to ask the simple question “After you conclude your analysis and it’s determined that risk levels are rising, what is your firms policy?” “I don’t understand.” I take a pause to re-word my question. “What steps does your firm take to address the risk and then mitigate the risk?” The answer is usually something like, “well, we do more analysis.” I then ask “does your firms ever set a hedging program into effect?” a blank stare, “What’s hedging?”

There are clearly two problems here.

the individual or firm who falsely believe there is no immediate concern and ample time for more profits. They will easily recognize the signs and take action when it’s needed;
the individual or firm who is completely unaware of the approaching storm and there is nothing they can do about it except to buckle up and hope for the best;

Would you be surprised to learn the first commodity exchanges were organized as a mechanism to hedge commodity risk? It’s quite true. Hedging is not necessarily complex, but you do require access to the derivatives market and need a derivatives specialist to understands the market.

Hedging is equivalent to insurance

You can’t accurately predict when you’ll need it, and you can’t control things which are not under your control. So to protect yourself and your property, the prudent person agrees to an insurance policy in exchange for an affordable monthly fee. The monthly fee is an affordable alternative to the high risk of not recovering after a disaster.

Hedging is much the same. In exchange for a small monthly fee, the firm mitigates their risk against an unforeseen event. For a business, this means an economic recession or a stock market reversal, either can be devastating. Will any of this happen tomorrow, can it be predicted in advance? Well sort of. In the winter months your risk of slipping on ice or snow is greatly increased. But the question we don’t know is if it will happen to a member of your family or perhaps to your neighbour.

Hedging your risk is not different. Will the economy move into recession or will it remain stagnant? Will it last 6 months or 24 months? We’re seeing interest rates rise with more to come. Corporate earnings are under stress. The economy of China is under pressure and Brexit is expected to throw the U.K. into a recession. Do you really need any more bad news to make you sit up and take notice.

Here’s what you need to do. Firstly forget what everyone else is doing because if you follow the herd, that same herd will lead you off the cliff. Make your own analysis of the situation and if you can’t survive another recession or don’t think having to lay-off staff is any kind of strategy then perhaps sound advice from a derivatives and hedging professional might just be the answer you’re looking for. Don’t know where to find one? No need to look any further because derivatives is not just what we do, it’s all we do. Make the call, you’ll be glad you did.