The Advent of Hedge Funds in the Gold Sector

Nevertheless, I often wonder what Julian would have made of the application of hedge fund strategies in the gold mining sector. He was continuously innovating, looking for improvements in his analysis techniques of companies and striving to identify moneymaking opportunities. I think for this reason he would be intrigued – maybe even supportive – whilst reminding us to be sure not to lose sight of what we pay per ounce of gold versus what we get!

600-Billion-Dollar Men

Hedge funds are by no means a new financial invention – as far back as the 1920s, investors were constructing portfolios composed of an equal dollar value of longs and shorts to ‘hedge’ themselves against the vagaries of the market.

The term applies to a multitude of different investment management approaches, but generally speaking, the common denominator is that hedge funds typically undertake some forms of shorting equities or indices in order to remove/reduce market risk, distinguishing them from a normal long only management approach. By reducing market risk, in theory the portfolio’s return will be purely down to the manager’s skills – and not market movement. Such an approach lowers the volatility of the portfolio, which appeals particularly to very wealthy investors who like the idea of capital preservation whilst hopefully making decent but steady returns on top.

In recent years, hedge funds have seen phenomenal growth in assets under management, now estimated to be at $600 billion. Doubtless the equities bear market has refocused investors’ attention on investment products that are intended to preserve capital. Although the growth rate has slowed recently, the hedge fund sector is one of the few areas of the investment management industry still making decent headway.

Although hedge funds have seen remarkable growth, they still remain a tiny part of the overall assets under management globally – probably under 1%. Of course, there have been a few notable corpses in the hedge fund world, not least Long Term Capital Management (LTCM).

The Holy Grail of the hedge fund industry has been to persuade pension funds that hedge funds represent an alternative asset class that should be considered for an allocation of assets. If the hedge fund industry can be successful in making this case, hedge fund assets under management could multiply several fold from here. News that CALPERS – one of the largest pension funds in the US – plans to invest $1 billion in hedge funds is significant. A discussion paper published by the FSA in the UK suggests that regulators are increasingly prepared to debate the issue, even if full blown retaliation of hedge funds may still be some way off.

Are hedge funds just another bubble, and will they become unfashionable with investors as soon as equities markets head upwards? Only time will tell, but as they have been in existence for so long my instinct is that they are here to stay. Many money managers who grew frustrated at running long-only money in bear markets and have started to undertake shorting strategies will be unwilling to give up this practice once it has proved profitable.

Indeed, sources in the Canadian broking world tell me that they have seen the number of accounts willing to short natural resources equities increase several fold in the past few years alone. Announcements have been made that two new gold funds are launching in Canada that will undertake limited shorting whilst retaining significant exposure to the market – so-called hybrid funds. Hybrid funds are a recognition that managers who claim to add value through stock selection, as many claim to do, can add even more value by undertaking shorting of the least preferred stocks in their investment universe. If funds that do undertake shorting are successful, gold ‘hedge-funds’ will become an ever-more important source of capital to gold mining companies.