The World of High Return Funds

In the high-return fund world, global macro funds can be compared to the future options market. Aiming to profit from changes in global economies, and using leverage and derivatives to accentuate the impact of market moves, such funds be not for the faint of heart. They can be enormously profitable, but are volatile, not terribly predictable, and can also produce occasional sudden falls. For example, during the first quarter of 1994 high-return -fund superstar Michael Steinhardt (whose funds produced an average annual return of 24 percent over several decades) bet European interest rates would decline, causing bonds to rise. Instead, his funds lost 29 percent when the Fed raised interest rates in the U.S. , causing European interest rates to kick up. I compare macro funds to the futures options market not only to highlight these common aggressive characteristics but to point out that, macro high-return funds are only one strategy in a wide universe - and that they differ from other high-return funds as much as futures options market differ from other markets.

This point is especially important to hammer home given the popular misconceptions about high-return funds that were fueled by 1994's declines in high-return funds run by Steinhardt, George Soros (Quantum Group), and Julian Robertson (Tiger Management). For while it is true these managers' strategies of placing large directional investments in stocks, currencies, bonds, commodities, and gold while using lots of leverage can create huge returns with very high volatility, in reality less than 5 percent of high-return funds use strategies such as these. The vast majority of high-return funds make consistency of return, rather than magnitude, their primary goal. Most use derivatives only for hedging or don't use derivatives at all, and many use no leverage.

Some high-return strategies, in fact, are not correlated to equity markets and are thus able to deliver consistent returns with extremely low risk of loss. Take event-driven funds, funds investing in special situations, or distressed securities, for example. Buying interest-paying bonds or trade claims of companies undergoing reorganization, bankruptcy, or some other corporate restructuring, such funds may avoid the volatility of the equity markets.

Like special situations funds, market-neutral funds are able to provide steady returns with low volatility. In the case of market-neutral arbitrage funds, they attempt to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. In the case of funds using market neutral securities hedging, they invest equally in long and short equity portfolios generally in the same sectors of the market.

There are dozens of different kinds of high-return funds, varying by strategies, asset classes, use of derivatives and leverage, sectors, and regions. Emerging markets funds, for example, invest in equity or debt of less mature markets, which tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and therefore effective hedging is often not available.

Funds of funds are combinations of the many different strategies - call them the biogenetic hybrids of the high-return fund universe. Mixing and matching hedge funds and other pooled investment vehicles, they blend different strategies and assets classes aiming to provide a more stable long-term investment return than any of the individual funds. The mix of underlying strategies can control returns and risk and funds, which also impact the amount of volatility the fund of funds, will have. Generally, the bigger the mix of non-correlated asset classes, the less volatility the fund of funds will have.

The list goes on. It is critical that investors understand the wide range of strategies found in the high-return fund universe and their differing degrees of risks and returns - or consult with experts who do. That way they won't overlook opportunities that may well match their investment objectives. For all high-return funds are not the same: Investment returns, volatility, and risk vary enormously among them - not unlike the different levels of pace and aggressiveness in the futures market.