Hedge Funds' "Bad Reputation"

I had yet another wedding to attend this weekend: My third in four weeks. I may never get all this rice out of my hair. Seriously.

But as I was driving to this happy event, a few questions rolled through my mind:

Was I dressed appropriately? (Not really.)

Was I going to make it before the bride actually walked down the aisle? (Just barely.)

Would there be a reprise of my “Footloose Dance” humiliation during the reception? (Thankfully, no.)

And then a strange thing happened. As I cruised onto the Ashland City Highway, a familiar tune pulsed from my speakers.

“An' I don't give a damn 'bout my reputation

The world's in trouble, there's no communication

An' everyone can say what they wanna say

It never gets better, anyway

So why should I care about a bad reputation anyway?

Oh no, not me, oh no, not me”

Yes – Saint Joan Jett had arrived to calm my nerves before I rushed into the small rural church, just in time for the wedding. To say I rocked those last five minutes of the drive would be an understatement.

When I awoke on Sunday morning, I was faced with a somewhat similar scenario. Hedge funds were skewered yet again; this time in an article by the New York Times referencing a study of eleven pension funds entitled “All That Glitters Is Not Gold.”  

The study demonstrated that hedge funds had added little value to public pension funds (in many cases underperforming the fund as a whole) and cost an exorbitant amount, based on the authors’ arbitrary 1.8% and 18% fee structure.  

The report concludes: “Although hedge fund managers have convinced many investors that they provide investment products so uniquely profitable that extraordinarily high fees are warranted, our research suggests that there is little evidence to back up these claims.”

Oh joy. Seems I’m not the only one that needs to be concerned with my reputation.

But, upon further study of the report, I noted a couple of interesting points that are, I think, at least worthy of consideration.

Time Periods Matter: Of the eleven pension funds reviewed for the study, nearly half included only the bull market period that started in 2009. There was no period longer than 13 fiscal years in the study (about the time the first pension funds dove into the hedge fund waters), and actually only one of those. For the pension plans that did include the 2008/09 fiscal year, in every case, based on visual interpretation of the line graphs, the hedge fund portfolios outperformed. So it would appear that, given the appropriate market environment, hedge funds can and do perform. So should we draw concrete performance conclusions on hedge funds’ performance during what has been a raging bull market? As we all know, if a fund is truly “hedged” it is nigh on impossible for that fund to outperform a market with its foot on the gas.

Manager Selection Matters: As investors, we make choices about our investments. Our choices are informed by the amount of money we have (or don’t have) to invest. They are informed by investment bylaws and state regulations. They are informed by the universe of investment options of which we are aware. They are informed by the amount of time we have to devote to our investment research. They are informed by our behavioral biases and those of other key decision makers. In other words, fund selection isn’t straightforward. Think about how hard it is to order a great entrée in a restaurant – and now picture that entrée costing thousands or millions of dollars. Get my drift? 

No matter how you look at it, each investor has some responsibility for their fund selection.  What’s interesting about this study is, again, based on eyeballing the line graphs, it looks like the plans reviewed generated hedge fund returns of about 8.3% in FY 2014. If you look at the NACUBO/Commonfund review of 832 endowments, in contrast, you see that they averaged a 9.9% return from “marketable alternative strategies.” Now, granted there could be a difference in terminology, or there could be something there. After all, I always say in investing, Your Mileage May Vary, and manager selection is a huge part of that. Even among the eleven managers in the "Glitters" study, there is a large variance in overall portfolio and hedge fund performance. 

So maybe the problem isn’t the investment vehicle. Maybe there is something that public pensions and others that are disappointed with their hedge fund earnings could learn or adapt from public endowments' approach to hedge fund investing. After all, endowments entered the hedge fund fray a bit before their public pension brethren. And, now this is just a thought, but looking at the largest endowments in the NACUBO study, they’re kind of kicking ass when it comes to hedge funds. Their marketable alternatives strategies returned 11.4% in FY’14, well above hedge fund industry averages and well above what others may be experiencing. What’s the what here? Should we be looking to those investors to figure out what ingredient we may be missing from our own secret sauce? It's not that the pensions included didn't do an admirable job of building portfolios, as each beat the overage hedge fund average, but is there something that could be done (structurally, in manager selection or otherwise) to boost returns?  

Fees, Fees, Fees: As I mentioned, the study uses an arbitrary 1.8% and 18% fee structure, even though we know that industry average is closer to 1.5% and 17%, but let’s even leave that aside for a moment. We really have no way of knowing what these pensions paid in fees unless it is publicly disclosed. If they went into a separate account, for example, they may have a totally different fee structure. If they negotiated a lower fee, that’s also difficult to know. In many cases, public pension “big dogs” are able to achieve fee concessions that us mere mortals cannot hope to get.

Does this mean I think there’s no wiggle room for hedge fund fees? Absolutely not. Those of you that are regular readers know that I generally support sliding scales for management fees in particular, based on the manager’s total AUM. But even then, it’s not a straightforward “Off with their fees!” equation. Some strategies are more labor intensive than others, which may require higher fees. Newer and smaller funds have very little room between profitability and problems in their fee structures. As in most things hedge fund related, there is not one-size-fits-all fee solution. Investors should advocate for themselves within reason, and managers should protect their ability to attract talent, execute strategy and generate returns for all their investors. It’s all about balance. 

It’s perhaps wise, then, to take a step back and think about whether we have enough data to draw actionable conclusions and, perhaps more importantly, if there is a way to improve hedge funds relationship and return contribution to public pensions. Anything else would be discarding the baby with the bathwater, based on what looks like a bad reputation.

Founding Funders?

Less than one score and seven years ago, it was relatively easy for hedge funds and other private fund vehicles to gain early stage capital. They went to their networks of high net worth individuals, let a little word of mouth work its magic, and then waited for early investments to roll in. Due diligence was minimal, who you knew was paramount and a rising tide (the Bull Market) lifted all ships. If it hadn’t been for the shoulder pads, it might have been the golden age of hedge funds.

Now, of course, raising early stage capital is a whole different ballgame. From seeders to bootstrapping to joint ventures to Founders’ Share classes, there are a host of options available to emerging managers who want assets, although frankly most work better in theory than they do in practice.

Lately, most of the buzz has surrounded Founders’ Share capital. And for managers that are unable to secure bulk early stage financing from a seeder, founders’ shares may hold some appeal.

Founders’ shares generally reduce management fees by up to 50 basis points, while incentive fees may be reduced by up to 5 percent. Founders’ shares are generally offered for a limited time for only early mover investors and are discontinued when a specific asset level or time threshold is passed. Founders’ Shares, and their reduced fees, remain in effect as long as the investor maintains an allocation to the fund.

Founders’ Shares have a lot of perceived benefits, including:

• Founders’ Shares sound cool. Seriously. Investors feel more like they’ve build something, and that can be appealing to some.
• They create urgency. Because Founders’ Shares are only offered until a certain AUM threshold is reached, or for a certain period of time, theoretically this “limited time offer” should encourage investors to pull the allocation trigger. Hey, it works for Ronco...
• They entice fee-wary investors without sacrificing the entire fee structure of the fund.

However, just because they sound good in theory doesn’t mean they are a panacea for every fund.

• Managers should consider the capacity of the fund. If the capacity is low, the amount allowed in founders’ share classes must be balanced to prevent a general loss of profitability for the fund.
• Institutional investors who insist on a “most favored nation” clause may be eligible to receive the reduced fee structure. As a result, it is important to discuss any legal ramifications of founders’ shares with counsel.
• Marketing materials must be created that clearly outline the opportunity for early investors. These materials (as well as any databases to which you’ve reported fees) must be updated when the initial “founding period” is over.

Perhaps most importantly, it’s important to remember that sacrificing fee revenue is most dangerous when assets under management are low. Once a firm or fund has attracted $1 billion in AUM, even a 1% management fee will generate $10 million in fee revenues in a flat year. For a $100 million fund, that fee revenue falls to $2 million in a 2% and 20% scenario, and $1 million in a 1% and 20% scenario (assuming flat performance).

And of course, those numbers are BEFORE expenses. Citibank estimates that a typical $100 million hedge fund must spend $2,440,000 each year to keep the fund running. Factoring that into the equation, it’s easy to see how quickly a fund can go from hero to zero, particularly if performance doesn’t pan out.

(c) 2015 MJ Alts

So I said all that to say this. Founders’ Shares can be a great thing if used judiciously, but please do the math to determine how much of a great thing you can stand to offer.

Are You The Next Blackstone? Don’t Count On It.

During an unbelievable number of meetings with investors and managers, I hear the same two refrains:

“We’re looking for the next Blackstone.”

Or

“We think we’re the next Blackstone.”

It’s enough to make you wonder if such success is commonplace or if we’re all overreaching just a teeny bit.

Well, I’ve shaken my Magic Eight Ball and the answer is this, at least for newer funds: “Outlook Not So Good.”

Recently, on a boring Sunday afternoon, I decided to go through Institutional Investor’s list of the 100 largest hedge funds and figure out when each fund company launched.

Yes, clearly I need more hobbies.

But the results (as well as my lack of social life) were pretty shocking. There are no funds within the top 100 that launched during the last 5 years. There are only 4 funds in the top 100 that launched within the last 10 years. In fact, nearly 70% of the top 100 hedge fund firms launched before the first iPod.

Obviously, this begs a question: Where are all the new Blackstones?

(c) 2015 MJ Alts

Whatever complaints can be lobbed at hedge funds, I do find it hard to believe that the talent pool has deteriorated to such a degree that there just isn’t a supply of skilled fund managers available. On the other hand, I do have a few theories on what forces may be at work.

1. Change In Investor Dynamics: For a long time, hedge funds were the investment hunting ground of high net worth individuals and family offices. In fact, pre-1998 saw little to no meaningful investment of institutional capital into hedge funds, and investment activity into hedge funds didn’t accelerate markedly until after the Tech Wreck. But by 2011, 61% of all capital in hedge funds was institutional capital. But why should this matter? Imagine you’re an institutional investor with $1 billion or more to invest into hedge funds. Imagine you have a board. Imagine you have headline risk. Imagine you are hit on by every fund marketer known to man if you go to a conference. Imagine you have policies that dictate the percent of assets under management that your allocation can represent. Now, try to put that capital to work in a reasonable number of high-performing hedge funds. It seems reasonable to assume that the investing constraints of being a large institutional investor would drive allocations towards larger funds with longer track records. Just like you never get fired for buying IBM, it’s unlikely you’ll be canned for investing with Blackstone, AQR, Credit Suisse or other big name fund complexes.
2. Market Timing: According to HFR, assets in hedge funds grew from $490.6billion in 2000 to nearly $1.9 trillion in 2007, or more than 287%. One of the reasons for this surge in assets is, I believe, prevailing market conditions. Having just exited one of the greatest bull markets in history and entered two of only four 10-year losing streaks in the history of the S&P 500, hedge funds had an opportunity to well, hedge, and as a result, outperform the markets. Unlike the last 6-ish years (recent months notwithstanding), where hedge funds have been heavily criticized for “underperforming” during an almost unchecked market run-up, market conditions were more favorable to hedged strategies between 2000 and 2008. This allowed managers with already established track records and AUM to capitalize on market and investor demographic trends and secure their dominant status going forward.
3. Evolving Fund Management Landscape: Let’s face it – the financial world was a kinder and gentler place before 2008. Ok, that’s total BS, but it was less regulated. Hedge funds were not required to register with the SEC, file Form PF, hire compliance officers, have compliance manuals, comply with AIFMD, FATCA and a host of other regulatory burdens. As a result, firms formed prior to 2005 did perhaps have an overhead advantage over their newer brethren. Funds today don’t break even until they raise between $250 and $350 million in AUM, and barriers to entry have certainly grown. Add to this that more than 90% of capital has gone to funds with $1billion+ under management post-2008 and a manager would practically have to have perfectly aligned stars, impeccable performance and perhaps have made some sort of live sacrifice to achieve basic hedge fund dominance, let alone titan status.

This is not to say that newer funds haven’t made it into the “Billion Dollar Club” or that rarified air of 500 or so hedge funds that manage the bulk of investor assets. It is, however, a stark look at how we define expectations and success on both the investor and manager side of the equation. If 40 is the new 30 and orange is the new black, is $500 million or $1 billion in AUM the new yardstick for hedge funds? Time will tell, but I’m wondering if the Magic 8-Ball isn’t on to something. 

Investment Wisdom May Increase With Age, Dance Skills Don't

As I prepare to move from one demographic checkbox to another later this week, I’ve been spending a fair amount of time wandering down memory lane. I’ve re-watched the movies from my youth, including Sixteen Candles, Ferris Bueller’s Day Off, Caddyshack and Smokey & The Bandit. I’ve gotten in touch with my inner Carlton Banks during a stirring, post-wedding live band rendition of “Footloose.” And I’m pretty sure when Loggins sang “everybody cut, everybody cut, everybody cut Footloose!” he wasn’t talking to me.

Property of Fresh Prince of Bel Air.

I’ve also spent a lot of time thinking about all the things I know now and all the stuff I have yet to learn. 

For my 45th year, I plan to keep learning as much as possible. I’m going to surf camp for a week. I will finally learn how to do a proper figure skating sit spin. I vow to discover how to drive with more limited use of my middle finger. And of course, I hope to continue to figure out how to be a better investor, researcher and snarky advocate for the alternative investment industry. 

When reflecting on what I do know I know, however, I did come up with some truths that constantly guide my investment decisions and unsolicited advice. They’ve become the North Star of my investment world, so to speak. And as luck would have it, there’s exactly one for each decade, with one to grow on. How fitting!

One: Continuous outperformance is a myth. Every manager screws up, gets caught with their portfolio pants down, or otherwise loses money from time to time. Finding the managers that minimize those downturns, can admit to and learn from mistakes, doesn’t keep making the same mistakes and, perhaps most importantly, live to invest another day is the real trick. Frankly, the only managers I’ve ever seen that never posted losses were frauds or, um, otherwise a bit creative in how they marked their portfolios. 

Two: Between investing early and late, I’ll take early any day. In 2006, I started researching the outperformance of emerging managers. In 2010, I started researching women and minority run funds. Thus far, investors have largely ignored those groups in favor of the same old, same old. As an investor friend of mine once quipped: “Investing in emerging managers is like sex in high school, even though everyone talks about it, no one actually does it.” Despite the lack of investors putting their money where my mouth is, I remain convinced there’s significant alpha to be had with these groups. The lesson? Just because the packaging doesn’t look familiar doesn’t mean there’s not goodies inside. The same thing goes for new trends for venture capitalists, out-of-favor investments, sectors or strategies. Early bird, meet worm.

Three: Any way you can invest involves risk. Whether you keep money in a checking account, invest in hedge funds, index funds, actively, passively, in real assets, conservatively or aggressively, there is a risk you will lose money or not make enough money, or that you will not have access to your money or otherwise lose out. My Grannie kept money stuffed in the pockets of the clothes in her closet because she thought that was risk free, but she missed out on any potential profits and, obviously, her returns lagged inflation. Not to mention: what if the house burned down? There are no risk-free investments. Period.

Four: Investment professionals (and anyone else) that truly want to rip you off will find a way to do so. Having said that, the best way for them to accomplish that is to build blind trust. After all, the “con” in con artist is short for confidence. Most of the big scams in investing couldn’t happen without trust, and most of the time those closest to the bad actor are the first to get victimized. Think Bernie Madoff who bilked members of his religious community and other friends and family. Obviously, you need to trust your investment professionals by all means or you’ll never sleep at night, but never forget to at least periodically verify.

And one to grow on: Look out for zebras, but don’t forget about the horses. A recent venture capital fraud case involved not a sophisticated cyber fraud or complex skimming techniques. The perpetrator merely added a “1” to a check, changing $8 million to $18 million. Occam wasn’t wrong: It’s not always the most sophisticated schemes or black swans that cause losses. Sometimes the ordinary can be just as dangerous. 

What’s the biggest lesson you’ve learned in your investing career? Feel free to sound off in the comments below with your best advice. And please follow me on Twitter (@MJ_Meredith_J) if you prefer your snark in 140 characters or less.

Dear Hedgie:

As a relatively new Tweeter (Twitterer?), I sometimes get questions from followers on a host of topics. In case you were also wondering, here are a few recent answers: Yes, there are almost always song lyrics hidden in my blogs. Actually, my hair is naturally large & no outside intervention is required. And yes, creating this much snark and sarcasm is exhausting.

Last week, I got the following question Tweeted in my general direction:

And while I can’t guarantee maximized profits, dear Tweeter, I can offer a few suggestions to enhance your first foray into alternative investments:

1. Take The Red Pill – The press loves, loves, loves them some alternative investments. And by loves, loves, loves I mean loathes, loathes, loathes. You’ve probably seen articles talking about excessive fees, billion dollar salaries, poor performance, insider trading, Ponzi schemes and other shenanigans and, I’m here to tell you, just because someone scribbled it on newsprint or online, doesn’t make it true. 

Take hedge funds, for example - they aren’t all gypsies, tramps and thieves, whatever you may have read. Fees are closer to 1.5% and 18% than to 2% & 20%. The vast majority of hedge fund managers make nowhere near the $11.3 billion that the 25 largest funds rake in, and are much more sensitive to reductions in fee income than you may think (see also http://www.aboutmjones.com/mjblog/2015/6/29/hedge-fund-truth-series-hedge-fund-fees). Insider trading happens, but is remarkably consistent at about 50 enforcement actions per year (across all miscreants, not just hedge funds). Ponzi schemes have happened but rarely at serious scale (and no, Madoff was not a hedge fund). Average performance of hedge funds has been lackluster but the top performers (who I’m pretty sure are the folks you want to invest with anyway) have generated some outstanding returns, even in the last few years. Don’t believe me? See the distribution of return graphics from Preqin’s latest study. 

Finally, there is no proof that hedge funds cause cancer, despite what the Hedge Clippers may say.

2.   Get a good data sample – One of the key mistakes I see from new investors in alternative investments, especially hedge funds, is the lack of a good data sample. The thing about hedge fund data is there is no requirement for any fund to report any information to any commercial hedge fund database. Period. As a result, the data is fragmented and incomplete. The only incentive for a fund to report to a database is to pursue assets. If a fund isn’t in asset raising mode, has a hearty network of prospective investors, or if the performance of fund is unlikely to attract assets, many funds simply won’t report. In addition, many funds report to only 1 or 2 databases, and if those don’t happen to be the ones to which you have access, well, that’s just tough cookies. The moral of the story? Invest in data. Buy data and gather information on your own by networking, going to conferences and talking to other investors about what and who they like. The only way to ensure you make the best investment decisions is to know what your options are in the first place.
 

3.   Think about what risk means to you – All too often, we try to boil risk down to a single data point. Whether it’s drawdown or standard deviation, we attempt to quantify risk because we feel like what we can quantify we can understand and control, right? Wrong. Risk means different things to different people and each investor will maximize different aspects of risks. For example, one investor may feel their biggest risk is not achieving a certain minimum acceptable return. Another may feel their biggest risk is losing a substantial amount of their investment. Yet another may feel headline risk is their biggest concern. And still another may worry about liquidity. The list is endless. The important thing for investors is to think about their personal (or organizational) definition of risk before making an investment, then identify the risks in any investment strategy as thoroughly as possible and finally determine if the potential upside is worth taking those risks. All investments involve risk. Period. Deciding whether the risk you’re taking is worth taking is up to you.

4.   Get your nose out of your DDQ – Get to know a manager and his or her team not just by grilling them with a long due diligence questionnaire, but by having a real conversation. If you know what’s important to a manager, what drives them, what keeps them up at night, how they got to where they are, what influences them, and how THEY perceive risk you have a much better chance of developing the rapport and trust that is necessary to any successful investment.

5.    Look ahead, not behind – If you’re chasing returns, you are already behind.

6.   Watch out for dry powder and Unicorpses – There is an awful lot of money flowing into private equity and venture capital and a finite number of reasonably priced deals, great management teams and fantastic business plans. Ensure any GP you plan to LP has the DL on deal flow.

7.   There is no I in TEAM – Actually, there is – it’s in the “A” holes. But I digress. My point is there is a lot of work associated with finding and doing due diligence and ongoing monitoring on alternative investments. If you don’t have a robust team, it’s ok to go to folks for help. Funds of funds, outsourced due diligence, OCIO, multi-family offices, operational due diligence firms, and other providers can be a lifesaver to a new or small investor in alternatives. It may not be cheap, but neither is recruiting, training and providing salary, bonus and benefits for an entire specialized team. Weigh what you can do in house against what you can easily outsource and spend the most effort on the voodoo that you do so well and money on the stuff that isn’t the best use of your time or expertise.

So there you have it: A small list of tips to help with first (or continued) forays into alternatives. Got a tip of your own? Put them in the comments section below.

Misusing These Popular Alternative Investment Terms? Inconceivable!

One of my favorite movies is The Princess Bride. Those of you that know me and my sense of humor probably aren’t surprised by that, but seriously, how can you NOT love a movie with R.O.U.S. (Rodents of Unusual Size), Miracle Max and a mysterious six-fingered man?

In fact, one of the best movie exchanges ever written probably appears in that movie. In it, the Dread Pirate Roberts is following Vizzini, Fezzik, and Inigo Montoya as they kidnap the titular princess, intent on malfeasance. 

Even as the Dread Pirate Roberts pursues them across an ocean of screaming eels and up the Cliffs of Insanity, Vizzini cries repeatedly that such actions are “Inconceivable!” Finally, Inigo Montoya declares: “You keep using that word. I do not think it means what you think it means.”

Comic gold? Absolutely.

Applicable to the alternative investment industry? Curiously, yes.

Recent interactions with various folks in the investment industry have led me to believe that Inigo may well have been speaking to us as well. In a number of cases, the words we use don’t mean what we think they mean. Perhaps we’ve selected them because they’re particular sexeh or they represent what we wish were true, rather than what is true, but regardless, we’re all sometimes guilty of creating a little linguistic anarchy by misusing investment terminology.

So, without further ado, and in no particular order, here are my top five investment terms that do not mean what we sometimes think they mean.

1. High Conviction and/or Concentrated– There is a growing body of research that supports the theory that high conviction portfolios generate higher returns. For example, a 2008 study from Harvard, the London School of Economic and Goldman Sachs found that, within U.S. Equity Mutual Funds, the highest conviction stocks outperformed the broad U.S. stock market and lower conviction stocks between 1 and 4 percent per quarter. Not too shabby. As a result, many investors like to see high conviction managers and many managers like to say they manage high conviction portfolios. But here’s a hint, it’s hard to have a portfolio of 50 high conviction positions. High conviction doesn’t just mean you LOVE your investments, it means you have fewer, larger positions, period. Which leads me to concentrated portfolios. As part and parcel of the High Conviction theme, I’ve come across an increasing number of managers who boast concentrated portfolios. Again, more than 50 positions does not a concentrated portfolio make. Take Warren Buffett for example. He usually has about 10 names in his book. Those keeping track, that’s conviction and concentration.
   
2. Unicorn – Merriam Webster defines a unicorn as “a mythical animal generally depicted with the body and head of a horse, the hind legs of a stag, the tail of a lion, and a single horn in the middle of the forehead.” The fact that it’s mythical means that the average Joe isn’t going to find a unicorn on his back porch eating the cat’s food anytime soon. In investing, a unicorn is a private company valued at $1 billion or more. As of March 2015, there were more than 80 unicorns according to CB Research, or just under the number from the prior three years combined. There are animals on the endangered species list with less population density. Perhaps we need a new term.
   
3. Emerging Manager – If you have a billion in AUM, and you’re not women, minority, or veteran owned, you are not an emerging manager. If you have $500 million in AUM, and you’re not women, minority, or veteran owned, you are not an emerging manager. If you have $250 million in AUM, and you’re not women, minority, or veteran owned, you are on the cusp (the top end) of being an emerging manager. If you are on Fund III, IV or V, and you’re not women, minority, or veteran owned, you are not an emerging manager.
   
4. Poor Performance – Underperforming an arbitrary and/or unrelated index is not an appropriate measure of performance. For example, comparing credit investments to the S&P 500. Comparing long-short equity investments to long only managers or long-only indexes. Determining whether something is good or bad relative to something else requires that the things being compared be largely similar to begin with.
   
5. Bottoms Up – “Bottoms up!” is a toast. Bottom-up is a way of analyzing information during the research process.

Seeing and hearing these terms misused in the investment industry makes my left eye twitch. Help save me from a lifetime of folks asking “Are you looking at me?” and start using these frequent used, but often abused, terms correctly.

Sources: http://www.globaleconomicandinvestmentanalytics.com/archiveslist/articles/499-the-case-for-high-conviction-investing.html, Merriam Webster, CB Insights

Investment Professional Fact & Fiction: The Business Trip

It’s funny, but I have a lot of conversations about all the travel I, and my fellow investment professionals, do in the course of our daily lives. For some reason, telling people that you “have” to go to New York, Los Angeles, Hong Kong, London, Paris, Monaco or some other “sexeh” locale puts all sorts of weird ideas into people’s heads. It’s like they think business travel turns you into P-Diddy or something. You’re big pimpin’ and you spend the cheese because you go to New York and stay at the W Hotel in Times Square for a night (Starwood whore!).

So, for those of you who wonder what all us lonely travelers do when we’re out on the road, I thought I’d sum it up for you. If either scenario sounds familiar to you, sound off in the comments section.

How Folks Picture My Business Trips

My (first class) flight leaves at a completely reasonable daylight hour. I was able to pack during work hours and therefore had no encroachment upon my “personal life.”

I arrive at the airport and whisk through security ‘cos, you know, frequent flyer street cred.

I board the plane and drink champagne or my alcoholic beverage of choice all the way to my destination, where I am picked up by a helicopter or limousine and deposited at my uber-chic hotel.

My first meeting is always a lunch meeting, which is somewhere swanky and leather and where martinis are swilled until it’s time for my next meeting, which, curiously, is also over drinks.

After that meeting I return to the hotel to return a few calls. Or nap. Or get a massage. You know…”work.” Maybe I even take time to sightsee or catch a show.

My dinner meeting is always somewhere fabulous that the average mortal can’t get into and where my meal costs more than a mortgage payment.

Everyone then adjourns somewhere similarly hip/swanky (depending on the friend) and then finally return to the hotel around midnight.

The next morning starts no earlier than a brunch meeting before I head to the world’s largest board room to make a presentation about how everyone secretly makes money but doesn’t tell “the little people” about it.

I then go to another lunch meeting, knock back a couple of drinks before collecting checks totaling eleventy-million dollars and boarding my (first class) flight home, having skipped security entirely because, let’s face it, I’m me.

How My Business Trips Actually Go

I almost never get a flight that leaves when it’s daylight. Whether that means I get up at the absolute crack of dawn or whether that means I schlep my bags to the office and work all day before racing to the airport to catch a flight that night, I rarely see the outside of an airport while the sun shines.

The whole time I’m en route to the airport, I am checking to see where I am on the upgrade list. However many first class seats are left, there is at least a 50% chance that I am that number plus one.

I do have TSA Pre-Check, but I seem to have a high “hit rate” for random extra screening. So I get often get felt up before boarding the plane. And it’s Nashville, so there’s often someone with a gun in the pre-check line. After security I rush to take my seat and put my earphones in (and/or feign sleep) before my seatmate can strike up a conversation about insurance, actuarial work, healthcare or some other topic I could care less about.

I arrive at my destination city and get in a cab. It usually smells like Fritos. Unless it’s been raining in which case it smells like O that didn’t stay with the B. And Fritos. (C’mon y’all, that helicopter thing was like TWO TIMES and it only happens for GAIM Monaco).

I drop by the hotel (which is either corporate or points-grabbing approved), but my room isn’t ready because it’s still WAY early to check in. I store my bags and run to my first meeting.

(Full disclosure: Sometimes I check in so late that the only rooms left are “accessible”, so I get to hang my clothes 3 feet off the floor…almost equally fun).

I generally have meeting scheduled back to back. A full day will have no fewer than 5 meetings, which is just doable if you don't have more than 30 minutes travel time in between each. My last meeting of the day may include a glass of wine, but otherwise, weirdly, there is no adult refreshment during the course of my day. 50% of the time I have a dinner to go to, and 50% I have a date with room service while I work on all the stuff that didn’t get done while I was flying around like a buzz saw all day.

At some point, either really late at night or super early the next morning, someone calls who has forgotten I’m in another time zone. I tell them it’s fine while wiping sleep out of my eyes and firing up my computer. Hint: I sound unusually perky when you wake me up.

The next day starts with breakfast at 8:00 where one or both people don’t really get to eat because they are trying to do work during the meal. I generally check out of the hotel before this meeting so I’m essentially homeless from now on, and schedule meetings back to back until I get back into a Frito-esque cab to return to the airport.

Flights home seem to have some sort of karma attached that makes them more likely to be delayed. I hang out in the Admiral’s Club doing work that I didn’t get done during the day and listening to other business people talk too loudly into their phones. I eat too many pieces of square cheese and brownie bites.

I finally get home (after dark) and go to bed. The next workday happens 8 hours or less later.

The moral of the story: Business travel? Super sexy. Sorry to spoil your fantasy. 

Crisis Communication for Investment Managers

Crisis communications isn't something most money managers practice very often. Well, I guess if they did, they probably wouldn't continue to manage money very long. But last week's market volatility was a great crisis communication "pop quiz" for investment managers. In case you failed the test, or if you just want to boost your score with investors, here are some tips for effectively communicating with investors and prospects during a crisis, whether it's market-driven or created by personnel, regulatory bodies, service providers, or litigation. Communicating effectively during a crisis can make or break a business, so study up and ace the next test.

(C) MJ Alternative Investment Research

The Love of the (Returns) Chase

Managed Futures/Macro funds reported investor outflows throughout 2014, ending the year down $35.06 billion and $19.13 billion, respectively. So, clearly the performance of these funds must have been sucked big time, right?

Yeah, um, not so fast.

On January 8, HFR reported that Macro/CTA funds had posted their 8th gain in 9 months, ending the year beating all other hedge fund strategies. In fact, they were one of the top performing strategies in the first quarter of the 2015, too.

And just like that, the chase was on. eVestment reported that Managed Futures and Macro hedge funds gained $14.18 billion and $4.01 billion in AUM, respectively, during the first half of 2015.

Ah! We fickle investors! Pretty soon we’ll probably just have a Tinder app for hedge funds and skip due diligence and asset allocation all together. The app will display only past performance and allocate straight into the limited partnership from your bank account. I smell a unicorn.

Swipe right if you agree.

(c) MJ Alternative Investment Research

It seems to be human nature to chase performance. Whether it’s due to overconfidence, miscalibration, Dunning-Kruger, familiarity, the disposition effect or simple greed and fear, we appear to be hard wired to make decisions based on past performance. Even if we know that PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS - or, as I like to put it, you ain’t gonna get what they got, you’re gonna get what you get. Unfortunately, the SEC isn’t keen on my translation, yet.

Now, don’t get me wrong. I loves loves loves a CTA/Macro fund. I wrote a paper when I was at Barclays showcasing the reasons why diversifying strategies such as these deserve permanent placement in a portfolio (and 2014 plus the last three days kinda proved my point), so it’s not that I’m anti-quant, systematic, macro, trend followers or anything else. And frankly, given the way the market has behaved over the last several days, this may be one of the few times when return chasing may actually work for investors.

Regardless of my personal biases and whether we’re about to enter the next great Stockapalypse, I do think it’s a good time to remind everyone that performance chasing is generally not a great strategy for great returns.

First off, all investors, no matter how large a pool of capital they command, are resource constrained to some extent. The amount of staff they have available for investment due diligence, operational due diligence and ongoing monitoring tends to be fairly finite. When you chase returns, you generally have to transfer resources from what one would assume is a rational investment plan to what amounts to a fire drill. At the end of the day, this can make your long-term investments suffer in favor of short-term (potential) gains.

And perhaps more importantly, return chasing simply doesn’t work. Studies of both retail and institutional investors show that fired fund managers often go on to outperform their replacements. In one Vanguard study, the average outperformance of a buy and hold investor versus performance chasers was 2.8 percentage points. In another (S&P/Dow Jones) study of U.S. equity mutual funds, past performance was not a predictor of future results 96.22% of the time.

In the alternative investment space, if you look at HFR’s Winner’s and Losers chart (you know, that colorful quilt like chart they produce annually) from year to year, it is rare to find a strategy in favor for more than 24 months at a time. Last year, it was CTA/Macro, the prior two years it was the S&P 500. 2011 saw Barclays Gov’t Credit in the lead. In 2010 the S&P 500 emerged victorious again. 2009 saw relative value – convertible win the race. 2008 was another win for Barclays. In 2007, it was emerging markets funds. In fact, Macro/Futures funds were in the bottom two strategies in 2012 and 2013 before topping everything else in 2014.

Let’s face it, past performance is not your friend, it’s your frenemy.

There are a lot of ways to make investment decisions that don't rely solely, or even primarily, on past performance of a particular fund or strategy. The outlook for the strategy, the qualifications of the manager, your own risk-reward mandate and parameters as well as a holistic portfolio plan can all be great guideposts during the investment selection process. 

Hell, you might even take a (gasp!) contrarian approach. 

I was speaking with an investor on Monday morning when the Dow was down about 1,000 points at open. While lamenting the loss, they also stated “well, at least it’s a good buying opportunity.” Those words made me want to do a little dance, make a little love, and get down on a Monday night (uh uh, uh uh). After all, our mantra is still buy low, sell high, not the other way around.

Oh, and PS - So proud I made it through that entire blog without an "I told you so" moment. Oops. Damn. 

Sources: HFR, S&P Dow Jones, Vanguard, eVestment

People Call Me A Skeptic (But I Don’t Believe Them)

I’m a data nerd. I know it. You know it. It’s not like it’s a big secret. My name is Meredith Jones, and I let my geek flag fly.

So it’s no wonder that my nerdy spidey senses tingled late last week and early this week with the release of two new hedge fund studies. The first was eVestment Alliance’s look at small and young funds - version 2.0 of the emerging manager study I first launched at PerTrac in 2006. The second study, authored by hedge fund academic heavy weights Andrew Lo, Peter Lee and Mila Getmansky, looks at the impact of various database biases on aggregate hedge fund performance.

Neither paint a particularly bright picture of the overall hedge fund landscape.

So why aren’t I, Certified Data Nerd and long-time research of hedge funds, rolling around on the floor in piles of printed copies of each study right now? Because, in addition to being a total geek when it comes to a good pile of data, I’m also a big ol’ skeptic, and never moreso than when it comes to hedge fund data.

Here’s the thing, y’all. Hedge fund data is dirty. Actually, maybe even make that filthy. It's "make my momma  want to slap me" dirty. Which is why it is critical to understand exactly what it is you may be looking at before jumping to any portfolio-altering conclusions. Some considerations:

One of the reasons I imagine Lo et al undertook their latest study was to show just how dirty hedge fund data is. They looked at backfill bias and survivor bias primarily, within the Lipper Tass database specifically. Their conclusion? When you adjust for both biases, the annualized mean return of hedge funds goes from 12.6% to 6.3%.

Ouch.

However, let’s consider the following:

No hedge fund database contains the entirety of the hedge fund universe. A 2010, comprehensive study of the hedge fund universe (again, that I completed for PerTrac) showed that 18,450 funds reported performance in 2009. Generally speaking, hedge fund databases cover roughly 7,500 or fewer “live” hedge funds. So, no matter what database you use, there is sample bias from the get go.

And while backfill bias and survivor bias do exist, so does participation bias.

Because a fund’s main motivation to participate in a hedge fund database is marketing, if a fund does particularly poorly (survivor bias) or particularly well (participation bias) it may stop reporting or it may never report. For example, of the top ten funds identified by Barron’s in 2014, three don’t report to Lipper Tass, two are listed as dead, two more aren’t reporting current data and three do report and are current. This could be sample bias or it could be participation bias. Hell, I suppose it could be survivor bias in some way. In any case, it does show that performance gleaned from hedge fund databases could be artificially low, not just artificially high.

As for emerging manager studies – they run into a totally different bias – one I’ll call barbell bias.

Unfortunately, due to wildly unbalanced asset flows over the last five years towards large funds, 85% of all hedge funds now manage less than $250 million. More than 50% of funds manage less than $100 million. Indeed, the hedge fund industry looks a little bit like this:

Some of you may remember my “Fun With Dots” blog from a few months ago. Using that same concept (each dot represents a hedge fund, each block has 100 dots and each line 1,000 dots, for a total of 10,000 dots, or funds) the Emerging vs. Emerged universe looks like this: 

(c) MJ Alts

What’s interesting about this is, at least mathematically speaking, every fund in the large and mid sized category could have been outperformed by a smaller fund counterpart, but because of the muting effect that comes from having such a large bucket of small funds, the small fund category could still underperform.

Now, of course, I still found both studies to be wildly interesting and I recommend reading both. Again: Nerd. I also know that people have poked at my studies over the years as well, which, frankly, they should. Part of the joy of being a research nerd is having to defend your methodology. In addition, most people do the best they can with the data they’ve got, but it’s not for nothing that Mark Twain stated there are “Lies, damn lies and statistics."

What I am saying is this: Take all studies with a grain of salt. Yes, even mine. 

In hedge funds - perhaps more than anywhere else, your mileage may vary. You may have small funds that kicked the pants off of every large fund out there. Your large funds may have outperformed your emerging portfolio. You may have gotten closer to 12% than 6% across your hedge fund universe (or vice versa). Part of the performance divergence may come from the fact that it’s hard to even know what the MPG estimates should be in the first place, which is why it’s critical to come up with your own return targets and expectations and measure funds against those indicators and not industry “standards.” 

Sources: Barron's, CNBC, Bloomberg, LipperTass, MJ Alts, PerTrac, eVestment Alliance

(Humorous) Perspective on the Due Diligence Process

After spending some quality time with managers and investors recently, I've come to realize that, while they have a lot of respect for one another, they also have a lot of frustration with one another's due diligence processes. Here's their thoughts about each other's due diligence in a (somewhat sarcastic) nutshell. 

Tongue in cheek? Perhaps. But I think there's more than a little truth in those cartoons. 

Maybe we should try to agree to exercise a little more peace, love and understanding about what drives the due diligence process from both sides of the fence. For managers, efficiently (if not perfectly) responding to every investor and due diligence request is paramount, since asset flows for most managers are tight. For investors, who are also resource constrained, eliminating managers quickly that won't 'make the cut' is key, while fiduciary responsibility and headline risk contributes to a high stakes process. I think both sides agree the process is far from perfect, but perhaps there are ways to tweak the process, rather than see the other side as an adversary.

The Wrong Barn Door?

Every Thursday there is a crisis at my house. A big one. It involves Hollywood movie scale running, hiding and yelling. The best FX team has nothing on the Matrix-like special effects that go on Chez MJ. And I can always tell the crisis is starting when I see this:

Yes, my Thursday Crisis is the Invasion of the House Cleaners. It’s scary stuff because, you know, vacuums and rags and spray bottles (oh my!).

How my cats learned to anticipate the Thursday Crisis is beyond me. I suppose there are subtle clues. I get up a little earlier to pick up and unload the dishwasher. (No judgment! I bet if I did a scientific poll about people who clean before their maids arrive the results would show I’m in the majority). I make a least one trip to the laundry room to grab clean sheets and towels. Whatever it may be, Spike and Tyrone have learned to watch for Thursdays with the diligence of Jack Nicolson guarding us against Cuban communism in A Few Good Men (“You can’t handle the vacuum!”).

For the rest of us, watching for the next financial crisis is a bit more nuanced. Last week, for example, I read two articles that made me wonder if we even understand what a crisis is, or if we all believe financial panic is as predictable as my housecleaners’ arrival.

The first article looked at the state of venture capital in the U.S. New figures, released by PriceWaterhouseCoopers and the National Venture Capital Association showed that venture capital investments in companies reached $17.5 during the second quarter of 2015, their highest totals since 2000. However, the article argued that, given that the total projected investment for 2015 (more than $49 billion) was less than the total amount invested in 2000 ($144 billion) and that the number of deals is lower as well, it couldn’t be another tech wreck-venture capital bubble in the making.

The second article looked at the risk precision of Form PF – a document introduced post-2008 to better understand and measure the risks created by hedge funds. The article cited two instances where hedge funds had proven their ability to destabilize economies: George Soros’ attack on the GBP in 1992 and Long Term Capital Management, the first "too big to fail", in 1998. Given that the hedge fund industry is now much larger than it was during those two “crisis”, it of course stands to reason that the risks created by hedge funds are now exponentially greater as well.

Or are they? 

Both articles were extremely interesting and presented compelling facts and figures, but they also were intriguing in that both seemed to assume that, at least in part, we experience the same crisis repeatedly. That perhaps we have a financial boogeyman waiting outside of the New York Stock Exchange every Thursday, much like my housecleaners.

But the reality is, a crisis is often a crisis precisely because we don’t see it coming. Each meltdown looks different, however subtly, from the one that went before. Which begs two questions:

1. Are we always slamming the barn door after the horses are gone?
2. And going forward, are we even worried about the right barn door?

Let’s look at a few financial meltdowns as examples.

1987 – Largely blamed on program trading by large institutions attempting to hedge portfolio risk.

1990s – Real estate crisis caused by market oversupply.

1998 – Asian markets (1997) plus Russia plus Long Term Capital Management– a hedge fund leveraged out the ying yang (technical term).

2000-2002 – The tech wreck. Could be blamed on “irrational exuberance”, changes to tax code that favored stocks with no dividends, or excessive investment in companies with no earnings (or products in some cases).

2008 – Credit meltdown created largely by overleveraged consumers and financial institutions.  Real estate crisis created by demand (not supply).

2011 – Sovereign credit issues, not a total meltdown obviously, but noticeable, particularly in many credit markets.

While these are gross oversimplifications of each period, it does show a clear pattern that, well, there ain’t much of a clear pattern. Bubbles happen largely due to macro-economic investor psychology. Everyone jumps on the same bandwagon, and then decides to jump off at roughly the same point. Think of it as Groupthink on a fiscal level. It isn’t easy to break away from Groupthink and it’s often even harder to spot, given that we’re often part of the group when the bubble is building.

So what’s the point of this little rant? Do I think we’re at a new venture capital bubble? I don’t know. The market has changed dramatically since 2000 – crowdfunding, Unicorn Watch 2015, lower costs for startups, and shows like “Shark Tank” are all evidence of that, in my opinion. And are hedge funds creating systemic risk in the financial markets? I don’t know the answer to that question either, but ETFs have now eclipsed hedge funds in size and robo investors are gaining ground faster than you can say “Terminator,” and LTCM was nearly 20 years ago, so it seems unlikely that hedge funds are the sole weak spot in the markets.

I guess I said all that to say simply this: If we spend too much time trying to guard ourselves against the problems we’ve already experienced, we’re unlikely to even notice the new danger we may be facing. If my cats only worry about Thursdays, what happens if the plumber shows up on Tuesday? Panic. If you drive forward while looking behind you, what generally happens? Crash.

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Sources: http://www.entrepreneur.com/article/248784, http://www.ibtimes.com/hedge-fund-risks-may-be-bigger-regulators-know-despite-dodd-frank-2033322

The Evolution of a Female Fund Manager

It's time for another jaunty infographic blog this week! This time we're looking at the sometimes rocky road from childhood to female fund manager. The excellent news? Parents, educators and employers can all help remove hurdles by being aware of these obstacles and taking small steps to level the playing field, and understanding and encouraging behavioral diversity in investment management. 

(C) MJ Alternative Investment Research

Trust Me, I’m a Portfolio Manager!

Last week’s post on the softer side of investing garnered a question from an intrepid reader:

Just how does a manager go about building trust and a personal relationship with investors and prospects?

Excellent question, and since I regularly offer unsolicited advice on how to further capital raising efforts, one on which I am more than happy to opine. So with very little ado, here are MJ’s Top Ten Ways To Build Better Relationships With Investors and Prospects. While this list isn’t quite as funny as the Top 10 Bad Names for Businesses (http://www.ultimatetop10s.com/top-10-bad-names-businesses/), it may just save you from closing your fund to become the next franchisee for this business. 

http://www.ultimatetop10s.com/top-10-bad-names-businesses/

Top Ten Ways To Build Better Relationships With Investors and Prospects

1. Have conversations, not monologues. When you walk in to give an initial pitch or a portfolio update do you spend the majority of the time giving your spiel? Do you doggedly march through your pitch book? How much time passes before you ask your audience a question? Before you launch into your pitching soliloquy, ask your audience some questions about themselves, their portfolio and their investment goals. Pause on your table of contents and ask, “Here’s what I would like to cover today, what would you like to spend the most/least time on? Are there other topics you’d like to address?” Take notes, plan your time accordingly, and instead of taking your audience on a PowerPoint Trail of Tears, tailor the time you have for maximum & (most importantly) mutual productivity.
2. Always tell the truth, even if the answer is “I don’t know.” This goes for you and your entire staff. I can’t tell you the number of times I’ve gotten one answer from a marketing/cap intro source and a different answer from a portfolio manager. Always remember: “I’ll get back to you on that.” is a perfectly acceptable reply.
3. Put information about your staff and other support personnel in your pitch book and DDQ. We all remember the phrase “Two guys and a Bloomberg” from the good/bad old days of investing. Well, my friends, those day are gone (if they ever existed). No portfolio manager is an island and, whatever your stud duck fantasies may be, it takes more than one person to manage money. Not including the firm’s staff in a pitch book (including outsourced services) creates two problems for investors. A) They have to ask how tasks get done, which an investor shouldn’t have to wonder and B) it may make them think that the manager does not value their staff. Employee turnover, particularly in CFO, CCO, COO, key analyst and other functions, can be almost as devastating to a fund as manager turnover, so I worry both about hubris and employee satisfaction when I don’t see a pretty little org chart. With names.
4. Talk about your background, but then, um, stop talking. I have met with managers who spent an entire meeting taking me on what seemed like a minute-by-minute tour of their professional bio. And don’t get me wrong: I care. I just don’t care that much. I can read your bio. I need to know what you see as the key inflection points and the highlights of why your background qualifies you to run the fund. I do not need an hour-long history lesson that starts off a la Steve Martin in The Jerk.
5. Call before bad news arrives… A fund of funds manager friend of mine has one cardinal rule: Call me before you end up in the Wall Street Journal. I would add to that: Call me before a large, out of character loss. Call me when your entire market segment is blowing up. Call me if one of your peers is having public valuation issues and tell me why you’re not and won’t. Give your investors and prospects a heads up and they will come to trust you more.
6.  …but don’t only call for bad news. If you only call when things are bad, investors develop a Pavlovian response to your phone calls. Call with good news once in a while (e.g. a really good month, a terrific new hire, a great new investor, you’re going to be on CNBC…).
7. Talk about what you’ve learned and how you learned it. One of the things many investors want to know about a money manager is what they’ve learned and that they are capable of continued learning. If a particular drawdown or market scare made you change your strategy or thinking about certain scenarios, that’s great to talk about. A long time ago, a prior firm had an investment with a manager that experienced significant losses during a market meltdown. When we sat with him to discuss the portfolio, he talked about that period and said that if he had it to do over again, he would sell off the book and start over. When the markets went into the pooper (technical term) in 2000, the manager did just that. He was able to avert large losses, he showed that he could learn, and he gained additional trust because he did what he said he would do, all in one fell swoop.
8.  Let people know what scares the pants off of you from a market or investment perspective. In 1999, I met with a famous money management firm to evaluate one of their funds for investment. I asked them about their worst market scenario and how they would react. They said that they couldn’t imagine a scenario where they wouldn’t see what was coming and get out of the way well in advance. Less than six months later they lost over 20% in one month. So much for that legendary foresight, eh? Every manager will lose money. Being honest about when and how a fund can lose money and how you plan to react lets your investors sleep better at night.
9. Don’t hide behind jargon, buzzwords, or opaque language. At a “speed dating” capital introduction event many years ago, a frantic event organizer begged me to go into the room with a fund manager who was, um, lonely. It seems investors came to his sessions but quickly received urgent calls or emails and had to depart. I attended his session and quickly learned why. The manager didn’t want people to figure out his “secret sauce” so he talked in the most pompous, jargon-filled manner imaginable. I wanted to shank myself with my coffee stirrer within 15 minutes. Hiding behind big words, complex math and opaque terms doesn’t make a manager sound smarter. It makes them sound scarier and riskier. It means investors have to ask questions that make them feel stupid. Word to the wise: When you make people feel dumb, they seldom give you money.
10. Know your client.  This goes beyond the B/D definition and fun compliance videos we've all had to watch and hits on a personal level. To the extent possible, make an effort to know key facts about every client. Where do they live? Are they married? Do they have kids? What do they like to do when they aren’t asking you every question on the AIMA DDQ? Being able to have an actual personal discussion moves your relationship out of simple transactions. Don’t underestimate the power of the personal connection.