To join the mystery-shrouded world of hedge funds you need money - oodles of it. Only the filthy rich can afford to frolic in this exclusive playing field, which probably accounts for its pervasive secrecy. But the hedge fund, an increasingly popular investment vehicle in the United States since the 1980s among those who can afford it, has also begun carving out a presence in Israel over the past few years.
Globally, hedge funds control about $2.3 trillion in assets, compared to $23.8 trillion for mutual funds at the end of 2011. While the latter are subject to ever-increasing supervision and growing transparency, regulation of hedge funds remains weak. But more and more hedge fund managers are coming to the realization that greater transparency is needed for the business to continue growing while remaining lucrative.
Hedge funds deploy investment strategies meant to generate profits under almost any market conditions by using a variety of financial instruments such as derivatives, short selling and high leveraging. Regular mutual funds, in contrast, rarely use derivatives and operate at low levels of leverage.
With hedge funds growing in Israel by leaps and bounds, the industry's dimensions and some of its characteristics are worth a closer look. Research performed by Tzur Capital Management, founded last year by Yitzhak (Yitz ) Raab, a former chief financial officer at asset management firm KCPS & Co., provides some interesting data and insights into the industry.
One of the aims of the research was to determine whether hedge funds in Israel constitute a serious business or merely a passing fad. The minimum investment in a local fund is $500,000 - a substantial sum, but well under the $1 million to $2 million entry bar elsewhere.
About 60 hedge funds operate in Israel, more than double the number here five years earlier. But only a couple of dozen are registered here; the remainder are registered in the United States, the Cayman Islands and the British Virgin Islands. Their place of registration determines whose laws they come under and which tax regime applies.
Israel's hedge funds manage about $2 billion - roughly NIS 8 billion - and employ about 300 people. Locally-based mutual funds, in contrast, manage NIS 154 billion and aggregately employ several thousand people.
Thirty-four hedge funds managing a total of about $1.6 billion participated in Raab's study. Since 2006, their assets have quadrupled. About 20% of the funds manage 75% of the assets - similar to the distribution in the rest of the world.
Whereas mutual funds need a critical mass of several hundred million shekels to remain profitable over time, hedge funds require much less. A hedge fund in the United States needs an asset base of $100 million, Raab said, but $30 million is sufficient to maintain profitability in Israel.
How large can this industry grow?
"Take Singapore, for instance: Several years ago, it didn't have any hedge fund industry. Today, it has $60 billion under management, thanks to encouragement from the government. So there is no reason it couldn't grow in Israel, too."
Raab identified five main investment strategies used by local hedge funds: the long/short equity model, in which every stock purchase is backed by the short sale of another stock, usually in the same industry; quantitative, also known as systematic, trading, which usually makes use of algorithms; global macro, which involves examining global macroeconomic developments like interest rate spreads (taking a low-interest loan in one country and depositing the money in another at a higher rate ) and trading in commodity contracts; event-driven, based on exploiting opportunities such as bankruptcies; and a combination strategy that involves combining some or all of the first four.
The long/short equity strategy accounts for the largest share of the market, but systematic trading - which has doubled in scope since 2008 - is the fastest growing. "Much of this strategy's growth comes from the popularity of algo [algorithmic] trading," Raab explained.
How much of the money raised for algo funds comes from abroad?