By Carl Delfeld of Chartwell ETF
As hedge fund titans face an intense grilling by
Congressional committees and thousands of hedge funds around the world are
closing their doors, perhaps it is time to consider a new approach. A
hedge fund structure offers investors many advantages such as maximum
flexibility but the model is sure to change under all the heightened scrutiny.
After specializing in country–specific ETFs since
2002, I am considering going out to raise seed capital for a fund focused on
deeply discounted Asian and emerging markets with a new structure that
addresses some of the current drawbacks of hedge funds, namely; liquidity,
transparency, leverage, risk management and fees. By using lots of cash,
trading short-term country ETFs and selective use of inverse ETFs, we have
managed to be up so far this year.
From the perspective of investors, a lock up
period of one or two years is a big problem especially in volatile markets and
when the fund’s investment strategy is not fully clear.
Another issue is the liquidity of the fund’s
investments. Is the fund able to sell investments to meet withdrawal
requests? And if markets move against a fund holding, can it be
liquidated without a severe loss?
Investors in hedge funds usually have only a
vague idea of what investments the managers are making. The argument for this
is that managers fear that their competitive position would be eroded if
holdings were made more transparent. One benefit of hedge funds is their ability to
use leverage in their investments but the investor may wish to see some limits.
Excessive leverage can lead to a disaster if markets move the wrong way. From their beginning, a key benefit of hedge
funds has been to mange risk better by hedging risks with the goal of making
money in both up and down markets. But investors are usually in the dark as to
what guidelines managers use to manage risk.
The standard hedge fee structure of 2/20 with an
annual management fee of 2% of assets and a performance fee of 20% over a
certain benchmark is likely to face compression. This must be balanced with the
need to have string financial incentives for managers.
The new fund model that I am considering would
address all of these issues. I would invest in only country ETF and
closed-ended funds offering good liquidity to investors and there would be no
lockup period. Investors could see Country ETF allocations on at least a
monthly basis. In terms of risk management, the use of inverse ETFs would be
limited to 20% of assets, no one country could account for more than 20% of
assets, trailing stop losses would lock in gains and limit losses, and the use
of leveraged ETFs would be limited as well.
For some investors, illiquidity and lack of
transparency is not a problem, but many investors want have a better picture of
strategy, risk management and holdings. The industry needs to provide more
options.
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