Expert View: On planet investor, hedge funds are 'going to the moon'

Phone calls after midnight are always interesting. A takeover, a fire in the office, a suicidal colleague - all experiences I've had (the first one five times). On this occasion, however, it was a call from New York, and one very excited young man who'd found religion - or, as we currently call it in the markets, hedge funds. His imagination was running away with him. "I had to call you - you simply must get in. This one's going to the moon and they'll ration the tickets."

Phone calls after midnight are always interesting. A takeover, a fire in the office, a suicidal colleague - all experiences I've had (the first one five times). On this occasion, however, it was a call from New York, and one very excited young man who'd found religion - or, as we currently call it in the markets, hedge funds. His imagination was running away with him. "I had to call you - you simply must get in. This one's going to the moon and they'll ration the tickets."

Yawn. Like all human activities, investment is subject to fashion, and there is no question what the mood music is at present.

I often hear references these days to the 1980s and 1990s "Cult of the Equity", which I presume is meant to describe the preponderance of equity holdings in personal and professional portfolios, and the enthusiasm for equity raised by new technologies. An overlooked part of this trend was the development of professional advisers and the role they played in assessing investment managers, whether for institutional or retail consumption.

In many ways, the rise of gatekeepers during the Cult led to far more sophisticated performance measurement. In its early stage, this was designed to show previously contented investors that while they might be overjoyed at their, say, 20 per cent return, they should be aware that the index itself had returned 21 per cent, so the growth was more market direction than skill on the part of the manager. This evolved into showing the investor that, even worse than this, the average of available managers had in fact returned 22 per cent. Performance started off being measured over several years, but this soon conflated to a quarterly assessment.

It was all good stuff - indeed, it now seems quite basic - but it led to unforeseen consequences. Managers were increasingly punished when they came low in the league tables, which led to them taking less and less business (ie investment) risk. They put more effort into finding out what each other was doing, leading to consensus hugging. As equity markets rose during the Cult period, managers scrambled to have ever more in equities. Some resorted to "closet indexing", others bet the farm on 100 per cent equity positions.

This was the state of the industry as we went into the worst bear market in a generation. Inevitably, investors were sucked down with the crowd, particularly those in passive funds. Is it any wonder they are now scared of equities and dismissive of league tables and relative returns? Who cares if your manager lost 2 per cent less than the others if you still lost 20 per cent of your money?

And so absolute, not relative, return is back in vogue, bonds are back in portfolios big time, and what equities you invest in must be with a specialist manager who is prepared to back his own judgement and ignore the herd. There is a desperate search for "alternatives" - property, private equity, hedge funds. Yawn. Private equity is embraced as if a new holy grail, but is it really any different to the venture capital funds of the 1980s? Hedge funds have grown enormously, but really because they are seen as guarantors of good old absolute returns. And only the most embedded investment professional can think of property as an "alternative" investment.

When this process started, I was working for a house of alpha stock-pickers who took big bets and ignored the herd. We balanced risk by holding lower equity weightings and concentrating on good absolute returns. Thanks to the "Cult of the Equity", the age of the league table, we were taken apart.

As I turned off the light and went back to bed, I smiled to think of how many of my old investment clothes were now back in fashion. Investors, beware of modishness.

christopher.walker@tiscali.co.uk