Learn to Love Volatility in Pursuit of Returns - UK Manager

Tom Burroughes

10 July 2008

Volatility is often regarded as one of the dirty words of the investment world, something to be avoided if at all possible among investors looking to preserve wealth. But at Eddington Capital Management, a UK alternative investments house, their managers are trying to urge investors to accept market swings as the inevitable price of a smart investment strategy over the long term.

Eddington, a firm which says it focuses on high-return investments, argues that investors who try to go for the supposed safety of low-volatility hedge funds are making a serious error. Attempting to cut out big price swings will not eliminate the danger of unknown adverse events, so the intended caution of a low-volatility investment strategy is an illusion, it says.

“If you lose 20 per cent in a low-volatility fund you will definitely bail out of it because there’s little chance of getting that loss back,” Glenn Baggley, chief executive and a founder of the business, told a gathering of journalists. His firm set up the Eddington Equity Opportunities Fund in May this year.

If his argument that low volatility is not the same as low risk is true, that will be welcome news to investors who, Mr Baggley says, are likely to see a significant rise in market volatility after what had been a relatively calm period in financial markets earlier in this decade.

As part of his case, Mr Baggley said that low volatility funds typically tend to be in crowded trades – where lots of other players are in certain markets – and such funds are tempted to use leverage to boost their returns, a tactic that can go wrong in a sudden market correction.

Mr Baggley also said that hedge fund returns are not correlated to equity market returns in the long run, and also denies that returns have been compressed by supposed over-crowding of the market by the rapid increase in the number of hedge funds in recent years.

In 1990, there were about 600 hedge funds worldwide and that number steadily rose to just under 7,000 in 2005 and yet that steady increase contrasted with huge swings in returns over that period, Mr Baggley said.

Eddington, which markets its fund products to institutions such as private banks, has put strong performance on the table for some of its funds. Its Eddington Triple Alpha Fund, a multi-strategy fund of hedge funds, has delivered returns since inception in 2003 of 84.03 per cent, beating the Hedge Fund Research Global Hedge Fund Index over the same period which had a gain of 25 per cent.

The firm is a joint venture between its founders and Caledonia Investments, the UK-listed investment trust.