LONDON Investors fed up with losses from their mainstream hedge fund holdings are eyeing some exotic alternatives.
How exotic? How about portfolios betting on Chinese companies embroiled in fraud probes? Or funds looking to arbitrage prices in the electricity market?
At this week's GAIM hedge fund conference in Monaco, investors were shaking their heads about where to generate returns, with many viewing so-called safe havens such as German Bunds and U.S. Treasuries as overvalued while equities look too volatile.
No surprise then that funds trading in niche areas, where profits are less to do with general market trends and more a manager's skill, are on investors' radar.
One hedge fund investor at the conference said he had achieved double-digit returns from investing in a range of more esoteric funds, such as those involved in electricity arbitrage, where a manager tries to profit from fluctuating prices by buying and selling electricity, and those trading the volatility of option prices.
He said the outlook for returns was "very unattractive to us in the mainstream strategies: long-short equity, event-driven, distressed, credit, CTA (commodity trading advisor), global macro", seeking instead less popular areas.
"We largely see the world as saturated," said the investor. "Basically, I don't want to be in a crowded room."
He also has money in funds shorting stocks of Chinese companies caught up in fraud scandals, and in funds involved in lending securities to borrowers for a fee.
Another example: the pension fund of UK bank Barclays is looking at investments in sub-Sahara Africa's fast-growing economies, and in hedge funds which play the reinsurance industry - a sector where insurers look to unload risk.
Big-name managers such as Dan Loeb, Steve Cohen and John Paulson have recently set up reinsurance firms, while pension funds are fuelling demand for "catastrophe bonds", which offer an income in return for agreeing to pay some of an insurer's claims if a hurricane or earthquake strikes.
Reinsurance prices often jump in the wake of big payouts by the industry after natural disasters - such as Japan's Tohoku earthquake in 2011 - as less well-funded players are forced to retrench, freeing those still in the market to charge more.
"It's truly uncorrelated," Barclay's chief investment officer Tony Broccardo said, referring to how little prices in the industry are linked to traditional equity or bond markets.
"After one of these big events, the pricing of securities becomes much more favorable for us."
The hunt for newer strategies - particularly those that don't lose money when stock markets fall - has become more desperate after a 2011 in which the average fund lost 5.3 percent while the S&P rose 2.1 percent, according to Hedge Fund Research.
Some of the most popular strategies fared particularly badly - long-short equity funds, which bet on rising and falling stocks, lost 8.4 percent on average, the researchers say.
Some see falling returns, and the need to look harder for profits, as inevitable as the $2 trillion industry develops having sucked in tens of billions of investor dollars in recent years.
"As an industry gets more mature, it gets harder to find real value," said one prominent hedge fund executive, who spoke to Reuters on condition of anonymity.
Delegates at the conference were particularly unimpressed with long-short equity funds.
However, finding alternatives can be tricky.
"At the moment it's easy to find a lot of (assets) that are quite unattractive," said Ian Prideaux, chief investment officer at Grosvenor Estates, which manages money for the family of the UK's Duke of Westminster, one of Britain's richest men.
One panel at the conference saw funds pitch their niche strategies to around 30 intrigued delegates.
They included the Directors Dealings Fund, run by Athanasios T. Ladopoulos, which tries to trace patterns in the buying and selling of shares by directors, in the belief that executives vote with their wallets when it comes to what they really think about the strength of their own company.
Funds accepted that while there were huge risks with some niche strategies, there were also big rewards on offer from those successfully pursuing a distinct or individual approach.
"People originally got into alternatives (assets) for alternatives," said Jeff Hudson, a partner at a fund trading U.S. municipal debt. "And if you look at everybody today, they all look the same ... Nobody does what I do."
(Editing by David Holmes)