Even if the songs tell us it's the most wonderful time of the year, when bells will be ringing and children are singing, for many emerging fund managers, the holidays may simply be the end of another difficult year of fundraising. To help you navigate any holiday season depression and just maybe put things in perspective a bit, I've put together a guide to managing the 5 Stages of Emerging Manager Grief. I hope it (combined with a lovely hot buttered rum) eases you through the holiday season.
November has been, at least thus far, a month of surprises.
You know that curse on the Chicago Cubs? Surprise! They won the World Series.
Didn’t I just see a Facebook post on a local norovirus (aka the stomach flu) outbreak? Surprise! I temporarily had to rename myself Vomitola Khomeni – and finally found that button I ate when I was three…
Hey! Do you remember all those polls that showed Democrat Hillary Clinton easily winning the White House? Surprise! Donald Trump is the 45th President of the United States.
Oh, and of course you recall all the dire predictions for the stock market should Donald Trump win the presidency? Surprise! The Dow Jones Industrial Average was trading in record-making territory a mere two days later.
To be honest, while I did spend much of the first part of the week “enjoying” my virus-induced weight loss opportunity, I also, if somewhat dimly and feverishly, realized that collectively we have done a terrible job of predicting recent events.
I know many in the financial industry had to have been stunned and dismayed by the election results. According to an October 26, 2016 article in Fortune, Trump raised $239,250 from hedge fund and private equity firms, while Hillary Clinton raised $45.2 million from the same groups. Charles River Ventures, a Silicon Valley venture capital firm even went so far as to entitle a blog posting “F*CK TRUMP.” Even though Republicans in other races enjoyed healthy and widespread financial industry support, it just wasn’t there for Trump.
As a result, for many people, last Wednesday morning must have seemed like the end of the world (as we know it). And while I didn’t notice any birds, there were even “snakes and aeroplanes” for any still doubting the seriousness of the situation. (https://www.theguardian.com/environment/2016/nov/08/snake-on-a-plane-passengers-flight-mexico-city)
So where do we go from here? How does the investment industry successfully navigate the new normal and survive and thrive in a new world order? Here are a few thoughts I had that may help investors and managers both do good while they do well.
One: Don’t Say Or Write Anything That Endangers Your Current AUM
This was a contentious election. Combative. Testy. Belligerent. Factious. Antagonistic. Insert every single synonym for “unpleasant and argumentative” you can come up with here, because no matter how you slice it, the 2016 political campaign was a dumpster fire, starting with the Republican and Democratic primaries and continuing through the general election. It. Was. Not. Pretty.
As a result, there are a lot of very strong post-election feelings on both sides of the aisle.
And as we extend our personas over Facebook, Twitter, Blogs, Instagram and other platforms, there has simultaneously been a reduction of social restrictions and inhibitions known as the “Online Disinhibition Effect.” It makes us more likely to say, write or post things that we likely wouldn’t have before.
When you combine those things – deep disappointment, hurt feelings and increased disinhibition – you end up with an improved likelihood of offending someone, inadvertently or otherwise. And when you seriously offend a client or prospect in this industry, your AUM suffers.
So lock down your Facebook account if you post politically on it. Don’t assume you know what someone’s views may be unless they’ve actually told you what their views are. In fact, to the extent that politics and social issues don’t impact your investment strategy or portfolio, don’t talk about them in professional settings. At all. Better safe than sorry because it’s easier to keep a client/investor than to acquire a new one.
Don’t believe me on this one? Ask Matt Maloney, who’s firm, GrubHub, suffered share price losses of 9.4% in the two days after the election over a leaked internal communiqué. Shut. It.
Two: Consider Diversity In Hiring and Investing
This election cycle has been, at least in part, about disenfranchisement. Trump likely won the election due to the disenfranchisement of the white, working class rural voter, while those who fear pending disenfranchisement (minorities, women, immigrants, LBGTQ) have fueled protests post-election.
The good news for investors and money managers is that inclusion will ease disenfranchisement, and it can also make everyone richer, too. Here’s how:
- Deszo & Ross studied the effect of gender diversity in the S&P 1500 and found that “female representation in top management leads to an increase of $42 million in firm value.”
- Orlando Richard found in his study that for “innovation-focused banks, increases in racial diversity were clearly related to enhanced financial performance.”
- Catalyst found that Fortune 500 companies with the highest representation of women board directors had significantly higher financial performance than those that don’t.
- Morningstar found that mixed-gender mutual fund teams outperformed single gender teams.
- The HFRI Diversity Index (+4.21%) has outperformed both the HFRI Fund Weighted (+3.59%) and HFRI Asset Weighted (1.31%) indices for the year to date through October.
- In a paper by Stanford professor Margaret Neale, diversity and intellectual conflict proved good for organizations. “When…newcomers were socially similar to the team, old team members reported the highest level of subjective satisfaction with the group’s productivity. However, when objective standards were measured, they performed the worst on a group problem-solving task. When newcomers were different, the reverse was true. Old members thought the team performed badly, but in fact it accomplished its task much better than the homogenous group.”
- Diversity includes “Functional Diversity” or “the extent to which individuals frame problems and go about solving them.” As a result, age, background and life experience should also be considered aspects of the diversity equation.
Certainly, in a rapidly changing world, having better problem solving skills and potentially better returns has to be a good thing, right? So cast a wide net when hiring staff or money managers going forward to maximize your cognitive alpha.
Three: It’s Still A Great Time To Focus On ESG Factors
So, early reports have the newly-elected administration throwing out both the Environmental Protection Agency and the CFPB, as well as doing away with Dodd-Frank, among other regulatory changes. While it’s too early to know whether and when that can or will happen, there are a few things we do know:
- 49% of high net worth (HNW) millennials (yes, they exist!) say that social responsibility is a consideration in investing. 53% of all millennials agreed. 43% of HNW GenX also consider social responsibility in investing. Due to demographic shifts in the workplace (these groups of workers are now larger than Boomers) and the looming generational wealth transfer, it probably makes sense to develop products that cater to these interests sooner rather than later.
- Bauer, Frijins, Otten and Tourani-Rad found “well-governed firms significantly outperform poorly governed firms by up to 15% a year” in their paper “The impact of corporate governance on corporate performance: Evidence from Japan.”
- A Wharton paper from 2012 shows a “positive association between corporate governance and performance…and evidence that higher corporate governance leads to an increase in cash dividends.”
- Exxon spent $2.1 billion cleaning up the spill from the Exxon Valdez, which, while recoverable, ain’t great for a company’s bottom line.
- Wells Fargo’s recent governance gaffe could cost the company up to $4 billion in revenue.
- GrubHub’s “hostile workplace” internal email has led to a boycott and a drop in share price.
It seems reasonable that ignoring ESG factors can cost you both potential returns and clients, and possibly increase portfolio risks. And even if there aren’t dedicated regulations or government bodies watchdogging, it also seems reasonable to assume that many investors (and the markets) WILL still care.
Four: Don’t Make Any Sudden Investment Moves
The Sunday before the election, I had a sudden Han Solo moment (“I’ve got a bad feeling about this…”) and decided that I needed to think about buying an inverse S&P ETF. I gave myself 24 hours to ponder and ultimately decided to stay my current course and not change anything in my investment portfolio. Lucky me, right? That single choice would have cost me. Bigly.
Humans want certainty. In a study published in Nature Communications, knowing there is a small chance of getting an electrical shock causes more stress than knowing you’ll be shocked.
Shocking!
But seriously, when you’re feeling uncertain about your investment strategy, take a moment. Take a walk. Take a breath. Take a sip. Take whatever step back you need before making any sudden investment decisions. Whether you’re an investor or a money manager or just a Star Wars fan with a retirement account, it’s important to remember that we generally invest for the long-term. Don’t risk your long-term goals chasing short-term “certainty.”
As for me, I’m taking my own advice. Right after I get back to my 80s roots, dig out my mismatched Converse high-tops from the very back of the closet, and have a 3-minute R.E.M.-party to dance it out. I invite you all to do the same.
Sources: http://fortune.com/2016/10/26/trump-hillary-clinton-hedge-fund-campaign-finance/
http://seekingalpha.com/news/3223875-grubhub-minus-5_8-percent-following-ceos-anti-trump-commentary
https://www.scientificamerican.com/article/how-diversity-makes-us-smarter/
http://corporate.morningstar.com/US/documents/ResearchPapers/Fund-Managers-by-Gender.pdf
https://www.hedgefundresearch.com/family-indices/hfri#
https://www.gsb.stanford.edu/insights/diverse-backgrounds-personalities-can-strengthen-groups
http://fic.wharton.upenn.edu/fic/papers/12/12-14.pdf
http://www.evostc.state.ak.us/%3FFA=facts.QA
https://www.ucl.ac.uk/news/news-articles/0316/290316-uncertainty-stress
In September of this year, a curious story started making the rounds on my Facebook feed. It seems that the CDC had underestimated the rate of cat scratch disease among the general population, determining that it was both more common and perhaps more severe than previously thought.
Folks in my feed freaked. The EFF. Out.
It can’t be! Little Fluffy how could you?!?
People on Facebook (and some media outlets) actually started asking questions like:
“Are you still willing to own a cat??”
“What about kittens? You can’t get a kitten now! They are even more prone to spreading the disease!”
“What if you have kids? Children 5-9 are most susceptible!”
Folks took special care to ensure the story hit my feed. As a crazy cat lady, they wanted me to both forewarned and forearmed.
And my reaction? After I got done singing “They give me Cat. Scratch. FEVER!” in my best Ted Nugent-esque voice, I laughed my cat-fur dusted butt off.
I’m guessing no one really made it past the headline of the article to see that the actual chance in contracting cat scratch disease was 5 in 100,000. That’s right, you have a better chance of injuring yourself in a “toilet related incident” (1 in 10,000) than you do of contracting cat scratch FEVER. Buckets and pails injured 11,000 people in 1996 (about the same number of folks that get cat scratch FEVER annually). Hell, air fresheners caused 2,600 injuries one year.
Y’all have seen the Darwin Awards - you know just about anything can be dangerous in the wrong hands.
But no, because people are well on their way to black belt status when it comes to specious claims and spurious correlations, somehow deadly kittens were news.
I had almost the same reaction (minus the Ted Nugent rocker style) two weeks ago when I came across the Bloomberg article “Hedge Fund Woes After U.S. Crackdown Don’t Surprise SEC’s Chair.” In it, the author notes that hedge fund returns have “fallen off a cliff “ since regulators and prosecutors cracked down on insider trading. Mary Jo White was quoted as saying “I don’t think anyone would argue that some of those returns at some hedge funds, and I don’t want to paint with too broad a brush, can be attributable to obviously trading on insider information that one is not allowed to trade on.”
The article then goes on to compare HFRI Equity Hedge returns to the S&P 500 November 2002-September 2009 and November 2009 to September 2016. Not sure what happened to October 2009, but whatevs.
Oh my. Where to even start?
I suppose the start of the SEC insider-trading crackdown could be traced to the charges filed against Raj Rajaratnam of Galleon in October 2009, which would account for the rather odd time period selection in the article.
However, information on insider trading enforcement actions seems to indicate that the number of actions was largely stable until 2015, hovering right around an average of 51, until a spike to 87 enforcement actions occurred in 2015.
I suppose you could say that high-profile hedge fund enforcement actions from 2009 on acted as a deterrent industry-wide. One could argue that fear of insider trading actually curtailed insider trading. All the compliance training, videos, quarterly disclosures, CCO reviews and whatnot that were instigated in the wake of SEC activities kept hedge fund managers too honest to continue their pernicious investment activities post-Raj's 2009 arrest.
Although, to be fair, compliance is generally designed to catch honest people. Money managers' who genuinely want to rip you off? They'll find a way to do so, compliance or not.
But regardless, I might argue that any crackdown that has occurred happened not in 2009, but in 2015 (a 70% increase in insider trading enforcement actions from the prior 10-year average is definitely notable), when, let’s remember, the S&P 500 lost 0.7% (without dividends reinvested) or gained a whopping 1.2% (with dividends reinvested), depending on your point of view. During the same period, the HFRI Fund Weighted Composite lost 0.85% (net), which makes performance during the actual crackdown time period a virtual tie, no?
Furthermore, HFR reported that 55% of funds posted gains that year. So maybe up to 5,500 funds were still engaging in insider trading, despite the crackdown and widespread compliance terror? Oh, and the funds listed in this Bloomberg article (http://www.bloomberg.com/news/articles/2016-02-23/the-top-performing-hedge-funds-of-2015), well I guess they were all tripping with the tipsters, too?
That’s a LOT of alleged (implied?) insider trading, my friends. A lot more than the actual 87 insider trading enforcement actions that took place that year. I guess all 87 of those enforcement actions must have been hedge funds, right?
Yeah, no.
According to an SEC publication on 2015 activities, “notable” examples of insider trading were listed as follows:
- An entrepreneur, a private equity investor and a venture capital general partner (walk into a bar?) investing in Cooper Tire;
- A former Fortune 500 exec and his brother-in-law;
- A former day trader, two of his friends and his brother-in-law (note to self, don’t talk freely in front of married-in family); and
- A Swiss trader
Were some hedge funds personnel charged with insider trading that year? I’m sure there were – there are some hedge fund personnel charged virtually every year. However, the fact is that the folks that get socked with insider trading come from all walks of financial and non-financial life. And even if EVERY case in FY2015 was a hedgie – it would still comprise less than 0.01% of the overall industry.
That’s right, a toilet injury is STILL more likely than hedge fund insider trading resulting in an enforcement action.
So if I’ve said it once, I’ve said it 1,000 times, but clearly it still bears repeating.
First, average not all hedge fund returns have lagged the S&P 500 in recent years. Some funds have done worse, some funds have performed well, and some have generated genuinely strong returns. Second, time periods matter. Third, the S&P 500 has been in a near-historic run-up and IS NOT HEDGED so it has no performance drag. Fourth, allegations of insider trading and hedge funds tend to be grossly exaggerated. And finally fifth – you’re pretty unlikely to get cat scratch FEVER from a sweet kitten – so visit your local shelter today.
Sources:
http://www.shape.com/lifestyle/mind-and-body/cat-scratch-disease-risk-prevention
http://www.care2.com/causes/youre-more-likely-to-be-injured-by-a-toilet-than-a-shark.html
http://factspy.net/40000-toilet-related-injuries-in-the-us-every-year/
https://www.hedgefundresearch.com/hfri-indices-december-2015-performance-notes
It’s that time of year again. The leaves are turning pretty colors. Kids are back in school. There is a real possibility of leaving my air-conditioned Nashville home without my glasses fogging upon hitting the practically solid wall of outdoor heat and humidity. And like any good Libra lass, I’m celebrating a birthday.
That’s right, it’s time for my annual orgy of champagne, mid-life crisis, chocolate frosting and introspection. Oh, and it’s time to check the batteries on the smoke detectors – best to make sure those suckers are good and dead before I light this many candles.
One of the things I’ve noticed in particular about this year’s “I’m old AF-palooza” is how much time I spend thinking about sleep. On any given day (and night), I’m likely to be contemplating the following questions:
- Why can’t I fall asleep?
- Why the hell am I awake at this hour?
- How much longer can I sleep before my alarm goes off?
- Why did I resist all those naps as a kid?
I even bought a nifty little device to track and rate my sleep (oh, the joy’s of being quantitatively oriented!). Every night, this glowy orb tracks how long I sleep, when I wake, how long I spend in deep sleep, air quality in my bedroom, humidity levels (in the South – HA!), noise and movement.
Yes, I’ve learned a lot about my nocturnal habits from my sleep tracker – for example, I move around 17% less than the average user of the sleep tracking system, I’m guessing due to having two giant Siamese cats pinning me down - but the one thing I didn’t need it to tell me was that I SUCK at sleep.
I’m not sure when I went from “I can sleep 12 hours straight and easily snooze through lunch” to “If I fall asleep RIGHT NOW I can still sleep 3 hours before my flight….RIGHT NOW and I can still get 2.75 hours…1.5 hours….” but it definitely happened.
I don’t drink caffeine. I exercise. I bought a new age aromatherapy diffuser and something helpfully called “Serenity Now” to put into it. I got an air purifier, a new mattress and great sheets.
But no matter what I try, I am a terrible sleeper.
I’ve concluded that it must have something to do with stress. I do spend an inordinate amount of time thinking about life, the universe and everything, so perhaps that’s my problem.
So in honor of my 46th year on the planet, I decided to compile a list of the top 46-investment related things I worry about at night. They do say admitting the problem is the first step in solving it, after all.
In no particular order:
- $2 trillion increase in index-tracking US based funds, which leads me to…
- All beta-driven portfolios
- Short-term investment memory loss (we DID just have a 10 year index loss and it only ended in 2009…)
- “Smart” beta
- Mo’ Robo – the proliferation (and the dispersion of results) of robo-advisors
- Standard deviation as a measure of risk
- Mandatory compliance training - don’t I know not to take money from Iran and North Korea by now?
- Spurious correlations and/or bad data
- Whether my mom’s pension will remain solvent or whether I have a new roommate in my future
- Politicizing investment decisions
- Did I really just Tweet, Blog or say that at a conference?
- Focusing on fees and not value
- Robo-advisors + self-driving cars equals Skynet?
- Going through compliance courses too quickly & having to do them over again
- Short-term investment focus
- Will I ever have to wait in line for the women’s bathroom at an investment event? Ever?
- Average performance as a proxy for actual performance versus an understanding of opportunity and dispersion of returns
- The slow starvation of emerging managers
- Is my industry really as evil/greedy/stupid as it’s portrayed
- Factor based investing – I’m reasonably smart – why don’t I get this?
- Dwindling supply of short-sellers
- Government regulatory requirements, institutional investment requirements and the barriers to new fund formation
- “Chex Offenders” – financial advisors and investment managers who rip off old people (and, weirdly, athletes)
- The vegetarian option at conference luncheons – WHAT IS THAT THING?
- Seriously, does anyone actually read a 57-page RFP?
- Boxes...check, style, due diligence...
- Tell me again about how hedge fund fees are 2 & 20…
- The markets on November 9th
- The oak-y aftertaste of conference cocktail party bad chardonnay
- Drawdowns – long ones mostly, but unexpected ones, too
- Dry powder and oversubscribed funds
- Getting everyone on the same page when it comes to ESG investing or, hell, even just the definition
- Forward looking private equity returns (see also: Will my mom’s pension remain solvent)
- Will my investment savvy and sarcasm one day be replaced by a robot (see also: Mo’ Robo)
- After the election, will my future investment jobs be determined by my membership in a post-apocalyptic faction chosen by my blood type?
- How many calories are in accountant-provided, conference giveaway tinned mints? (See also: conference chardonnay)
- Why are financial advisors who focus on asset gathering more successful than ones that focus on investment management? #Assbackward
- Dunning Krueger, the Endowment Effect and a whole host of ways we screw ourselves in investment decision making
- Why divestment is almost always a bad idea
- Active investment managers – bless their hearts – they probably aren’t sleeping any better than I am right now
- Clone, enhanced index and replication funds – why can’t we just K.I.S.S.
- The use of PowerPoint should be outlawed in investment presentations. Like seriously, against the actual law - a taser-able offense.
- Will emerging markets ever emerge?
- Investment industry diversity – why is it taking so looonnnnggg?
- Real estate bubbles – e.g. - what happens to Nashville’s market when our hipness wears off? And is there a finite supply of skinny-jean wearing microbrew aficionados who want to open artisan mayonnaise stores that could slow demand? Note to self, ask someone in Brooklyn….
- Did anyone even notice that hedge funds have posted gains for seven straight months?
Yep, looking at this list it’s little wonder that sleep eludes me. If anyone can help alleviate my “invest-istential” angst, I’m all ears. In the meantime, feel free to suggest essential oils, soothing teas and other avenues for getting some shuteye.
Sources and Bonus Reading:
Asset flows to ETFs: https://www.ft.com/content/de606d3e-897b-11e6-8cb7-e7ada1d123b1
Recent HF Performance (buried) http://www.valuewalk.com/2016/10/hedge-fund-assets-flows/
HF Replication: http://abovethelaw.com/2016/10/low-cost-hedge-fund-replication-may-threaten-securities-lawyers/
Average HF Fees: http://www.opalesque.com/661691/Global_hedge_funds_slicing_fees_to_draw_investors169.html
Political Agendas & Investing: http://www.njspotlight.com/stories/16/10/03/murphy-adds-plank-to-platform-no-hedge-funds-in-pension-and-benefits-system/
Asset Gathering vs. Investment Mgmt: http://wealthmanagement.com/blog/client-focused-fas-more-profitable-investment-managers
World's Largest PE Fund: http://fortune.com/2016/10/15/private-equity-worlds-largest-softbank/
Spurious Correlations: http://www.bloomberg.com/news/articles/2016-10-14/hedge-fund-woes-after-u-s-crackdown-don-t-surprise-sec-s-chair
Short-Term Thinking - 5 Months Does Not Track Record Make: http://www.cnbc.com/2016/10/14/venture-capitalist-chamath-palihapitiyas-hedge-fund-is-outperforming-market.html
Every time I turn around, I find a manager looking for seed capital. Many are frustrated with what I like to call "second dollar syndrome" - the fact that everyone seems happy to be the second dollar in your fund, but few want to commit the first dollar - and dream of a seed investment as a way out of the fund raising drudgery.
If you're on the early-stage capital trail, it can be helpful to understand the nuance of seeding and acceleration capital so you know better when to hold 'em and when to fold 'em, know who's 'bout to walk away and who's there to fund. So here are a few pointers that apply to seed and accelerator capital (even if it just says seed in some spots for brevity's sake) that I hope lead you to your own vat of miracle grow.
Dear MJ:
About 10 years ago, I became involved with a very special investment. I had my eye on it for a while, you see, and had noticed things about this investment that really appealed to me. It was different than the other investments I had known, less restricted, and, dare I say it, maybe even a little uninhibited. But it seemed to always be there for people when the markets were down, and that really turned me on.
I started looking into getting involved with this investment and, based on what I was able to research, learned that others had a generally good, though occasionally volatile, relationship with investments similar to mine. I saw how happy those family offices and high net worth individuals were over the long term. I watched their investments support them through the tech wreck, and I wanted a that special relationship, too.
But as much as my heart screamed “invest!” my head, and the heads of those around me urged caution. So I gave in, but not without a few stipulations. The investment would have to change, you see. Not the things I loved – no, I wanted the long-term happiness and the unwavering support. But I didn’t want our relationship to be volatile. And the freedom, well, that made me a little nervous, too. And I really wanted my friends to like my investment, too. So I asked it to clean itself up, move into better digs, and I insisted it hire people to ensure it didn’t step out of line. I even hired people to monitor it, too. And several people close to the investment? Well, they promised it would never hurt me.
Now, 10 years later, our relationship has changed. My investment doesn’t make me as happy as it should. It’s like it’s not even trying. Some of my friends have become disillusioned with my investment, and a few are even pressuring me to dump it. They argue that I pay for everything and am not getting much out of it in return.
So, Dear MJ, what’s an investor to do?
Signed,
Hedged Up
My Dear “Hedged Up”:
I’ll be honest: I’ve received quite a few letters like yours lately. Egged on by a strong market, vociferous press coverage and contentious board meetings, there’s a lot of fed up investors all over the world right now wondering how we got here. I’m not entirely sure I have the answers, but as an investment voyeur for more than 18 years, I can definitively say that the investment you fell in love with? Well, it’s changed.
In the late 90s up through most of the tech wreck, I was working at Van Hedge Fund Advisors, which some of you may remember as one of the first consultants that worked with investments like yours. At that time, our proprietary database tracked just under 5,000 funds. Some were good. Some were bad. Some ended up being frauds. At least one, Long Term Capital Management (“LTCM”), blew up spectacularly during my first six months on the job.
Our clients were primarily high net worth individuals and small family offices. We worked with some endowments and wealth management firms, but, in general, the client base was not institutional. In fact, per Citibank, only $125 billion of hedge fund assets under management (or roughly 20%) were institutional prior to 2002.
Returns prior to LTCM were reported by fund managers to Van Hedge primarily quarterly, changing to monthly starting in 1999. By 2000, all of our funds were reporting at least monthly. After the market started melting down, most of our key hedge fund relationships also provided weekly estimates, although many portfolios remained relatively opaque. Funds had wide latitude to do what they wanted when they wanted, and the words “strategy drift” had not gained traction.
Staff was lean. The term “two guys and a Bloomberg” was used to describe funds and it wasn’t meant as an insult. The SEC periodically audited those funds registered as investment advisors, which most were not, and overzealous compliance had yet to become the norm.
Performance, on average, was quite strong, although more than a few “long/short equity” funds were more than 90% net long, capturing the returns of the “greatest bull market in history.” When the market began to sell off, hedge funds in general also flourished (although those 90% net long funds lost their butts). “If there is one thing at which hedge funds excel, it is in avoiding highly publicized, highly priced investments that indexes, by virtue of their construction, must own. Most hedge funds shone during the 2000-02 technology sell-off,” noted even a September 2016 article on the infamous “Buffett Bet” against hedge funds.
Was the relationship between funds and investors perfect?
Hell. No.
Did fund managers occasionally fake their own kidnappings or end up on 20/20?
Hell. Yes.
But it was what it was. And what it was spawned the investment profile you were so attracted to initially.
And now?
Well, now we’re in an entirely different ball game. The amount of money, the type of investor, the expectations, the regulations, transparency, the number of managers….well, they’re ALL different. And it would be ludicrous to think that those wholesale changes would not have an impact on your investment individually, and on the industry overall.
So what’s changed?
Assets Under Management – The size of the hedge fund industry more than doubled between 2002 and 2007. It grew from $625 billion to $1.8 trillion in five years per Citibank, and the main driver of that growth was some $750 billion in assets poured in by institutional investors. That’s a lot of cash for any industry to eat without some serious indigestion.
Number of Funds – The number of funds increased from the Van Hedge database of 5,000 to the widely accepted industry average of 10,000 between 2002 and 2007. That’s a helluva lot of new funds. Wannabe fund managers flocked to the hedge fund industry to capture higher than mutual fund fees and assets flowing like champagne at a P-Diddy party. And, because hedge fund-land ain’t Lake Woebegone, every fund is not above average. Some of those new entrants struggled to put up decent performance numbers. Prior to 2010, low barriers to entry meant those funds could bootstap a business for years with friends & family funds and few expenses. Now those funds are getting shaken out of the industry. Frankly, that probably needs to happen – those funds aren’t helping industry averages or its street cred. But, overall, I still believe there is a tremendous amount of talent in the hedge fund industry. You just may have to diligence more frogs to find it.
Type of Investors – The HNW individuals and family offices Van Hedge dealt with didn’t really care if they had daily transparency, if a manager invested in something off the beaten path, or whether there was a dedicated CCO, COO, and CFO at the fund. SEC registration wasn’t an issue, nor was an “institutional quality” back office. Concentration limits and stop losses were nice, but not necessary. Was this perhaps a little naive and potentially even a little dangerous for investors? Um, yeah. Sometimes you were the windshield and sometimes you were the bug. But, it has to be said, the expectations, controls, investing parameters and infrastructure that was expected by institutional investors starting in 2007 has a cost associated with it, both in terms of actual expenses (which reduce returns) and in lizard-brain opportunity costs. In today’s investing environment, you may never be the bug, but you’re also a lot less likely to be the windshield.
Marketing – In my early days at Van Hedge, hedge funds were pretty honest about what they were. Many fund managers did their own marketing and stressed strategy, smarts, nimbleness, and a willingness to adapt, adjust, and evolve. Over time, that messaging evolved. The concept of “absolute return” was introduced and almost immediately bastardized. I will never forget a business trip to Japan post-2008 when many of the investors I talked to had been sold hedge funds as a fixed income substitute. WT-Actual-F? Absolute return was never meant to imply that an investment absolutely generates positive returns every month, quarter, year or rolling period, and those that marketed that way did the industry, and investors, a tremendous disservice.
In short, the investment you fell in love with, Dear Reader? It HAS changed - in part, because you asked it to, in part because it was a victim of its own success and in part because expectations on both sides of the fence became disconnected from investment reality.
The question for you, Hedged Up, and for all of those who are disappointed with their “absolute return” portfolio is this: Can you remember what really attracted you to the investment in the first place? Was it the performance? Was it the diversification? Was it the correlation? Was it the belief that you’d never know a single moment of return sadness? Once you’ve figured that out, Dear Reader, you can take a step back from your former investment love and see if there are ways to achieve those goals within today’s hedge fund landscape. I just bet you can find true investment love this time..
Sources: http://www.citibank.com/icg/global_markets/prime_finance/docs/Opportunities_and_Challenges_for_Hedge_Funds_in_the_Coming_Era_of_Optimization.pdf
http://news.morningstar.com/articlenet/article.aspx?id=769179
It's often quite amusing to me to chat with friends and associates outside of the investment industry about the investment industry. The vision that many folks have about the typical hedge funders' day-to-day existence is one part conspiracy theory, two parts lies and debauchery and a final part douchebaggery. So, to help clear up some of the most common misconceptions about working in alternative investments (specifically hedge funds), I thought it might be helpful to create a simple visual aid separating hedge fund fact from fiction. May this give you a giggle as you attempt to re-acclimate to work after the long weekend.
Please note: I don't think that the hedge fund industry is in imminent danger of going away, but I do think that, like in Westeros, there will likely be some carnage before we make it through this round of poor average performance and fee, tax and regulatory pressure. Oh, and I don't own any of the images above. And finally, you may have to be 40+ or a bone fide cinematic geek to understand some of the references (Hint: Trading Places, Dr. No, Hitch), but I think you'll get enough of the picture. That is, hedge funds: More PowerPoint than "power suit, power tie, power steering."
My ex and I parted ways about a year ago. After taking some time to eat some ice cream, clean out my closets and get my personal feng shui back in order, I decided recently it was time to re-enter the dating scene.
Unfortunately, as someone who A) works from home and B) travels extensively, I realized that meeting men who weren’t delivering FedEx packages or patting me down in the airport was going to be a bit challenging. So I bit the bullet and did the online dating thing.
Color me PTSD’ed.
My first day at the online ‘all-you-can-date’ buffet saw me literally innundated with emails. “Hey!” I thought. “I must still have it!.”
But then I started to actually open those emails and realized that nearly all of the men who had emailed me could be categorized into one of three buckets:
- Men holding things they had killed;
- Men my dad’s age and older; and
- Curiously, Civil War re-enactors (As an aside, do folks not realize the South actually lost the Civil War? I mean, isn’t that kind of like re-enacting the Titanic sinking over and over again? Big fanfare. Long denouement. Everyone dies. But I digress…)
Ho-lee-shit.
My mind started racing.
“Well, if this is the best that’s out there for me these days, I’m going to be single forever,” I thought.
“Do you suppose they have nunneries for spiritual, not religious, former Presbyterians-quarter Jews whose favorite form of cardio is shopping and who want to endow the cloister not only with their worldly ‘dowry’ but with vast amounts of high quality hair gel???” I wondered.
Seriously. My dating life was over. Kaput. I was hopeless. Driven to salted caramel ice cream, red velvet cake, NeimanMarcus.com and re-runs of the BBC's Pride and Predjudice in an instant.
And then I realized something.
I had fallen for literally one of the oldest tricks in the mind’s playbook. Instead of considering the known unknowns (i.e. – the thousands of men online and in the physical world from whom I hadn’t received disturbing, Santa Clause-esque pictures), I had taken the known knowns and concluded that I would eventually die alone and be eaten by my cats. And don’t even get me started on the unknown unkowns in this scenario. I mean, Bridget Jones-type endings don’t just happen in the movies, right?
Daniel Kahenman explained this information processing phenomenon in his book Thinking Fast And Slow as “what you see is all there is (WYSIATI),” and I was a classic victim.
But it was somewhat comforting to me to remember that I’m not the only one that falls for this little mind game. The investment industry does it all the darn time. In fact, it’s one of the things that makes me the kinda tired about the work I do.
Don’t believe me? Think about the following areas:
Hedge Fund Returns: A classic example of WYSIATI, we all know that hedge fund returns have been positively tragic for years, right? I mean, we see the HFRI Asset Weighted Index is down -0.21% through July and that obviously means that all funds have struggled to post any kind of decent returns. Well, hold on there a minute, Sparky. What if I told you that looking at that one number was giving you a bad case of the known knowns? What about all of the other funds in the HFR database? I guess they’re underperforming, too? Nope. Even if you look at other index categories you can see instances of strong outperformance: Credit Arb – up 5.17%, Distressed – up 6.20%, Equity Hedge Energy – up 10.73%, and those are all averages. Or what about the small funds I'm always pushing on y'all? They are up 4.1% for the year to date, according to industry watcher Preqin, compared with a somewhat anemic gain of 0.54% for the "billion dollar club." In fact, these numbers are the known unknowns – the numbers we could consider, but we don’t because there’s a nice, neat single little index number for us to rely on. And then you’ve got the unknown unknowns – the funds that DON’T report to HFR and aren’t accounted for in their index. I know of funds that are up 10%, 15% even 20%+ for the year. In a universe of 10,000 funds, drawing conclusions from one bit of known known data just doesn’t cut it.
Diversity: In April 2015, Marc Andreessen famously said in an interview that “he has tried to hire an unnamed woman general partner to Andreessen Horowitz five times. Each time, she’s turned him down.” See? Even a luminary in the venture capital world can get sucked into WYSIATI. Because the “unnamed woman” was likely one of the few females Andreessen associates with in the industry, she constitutes his entire universe. She is his known known. And if you think there aren’t great women and minority candidates, funds or investment opportunities out there, the problem is likely with you. Cultivating different networks, rewriting job descriptions to attract different applicants, working with recruiters who specialize in diversity, hell, even just being more intentional about hiring and investing can reveal a wealth of candidates that can help bring cognitive and behavioral alpha to your firm.
Fund Fees: Hedge fund fees are 2 and 20. 2 and 20. 2 and 20. I hear (and read) this so much I want to vomit. Do some funds charge 2 and 20? Sure. Do some funds (read: most funds) charge less, if not in headline fees, in actual fees? Hell yes! The average fees for a hedge fund these days is about 1.55% and 18% and declining. For new fund launches, fees were remarkably stable for years, never approaching the 2 and 20 milestone on average. And what’s more, roughly 68% of funds in a Seward & Kissel study offered reduced fees for longer lock ups, while 82% of equity funds and 29% of non-equity funds offered reduced-fee founders share classes. And what about hurdle rates? An investor recently swore to me that “no hedge funds have hurdle rates.” Well, that’s just bupkis. A show of other investor hands in the room immediately dispelled that myth, proving that, while not the majority of funds, some funds do have benchmarks to beat before they take their incentive allocation. What that one investor saw was not all there was.
Indices: Can’t Beat ‘Em, Join ‘Em: Obviously, the entire investment industry is trending towards passive investments. You can’t swing a dead pouty fish without hitting an article touting the death or underperformance of active investment management. And for people who have only been investing over the last 10 years or so, it probably looks like the S&P 500 is a sure bet. Always goes up, right? Well, wrong. While it’s certainly true that the S&P does tend to go up over time, you can never be sure what the time frame will be, and whether you’ll have time to recover from any unexpected downturn. But the bull market we’ve seen since March 9, 2009 isn’t all there is. Actually, if you recall, at that point in time, the S&P 500 had just experienced a 10-year losing streak. Ouch. Don't believe me? Ask any Gen X'er like me how much Reality Bites when the first 10 years of your 401k saving is wiped out by a tech wreck. Sorry, Millennials, but you haven't cornered the market on false financial starts quite yet.
Investment Opportunities/Herding: Private equity and venture capital dry powder with nowhere to go. Hedge funds all own the same stocks. Crowded trades. High valuations. What investor could possibly make money in this environment? Once again, 13-Fs, Uber and Apple aren’t all there is. Even though we tend to fixate on the visible data, there are a number of niche-y, networked, regional, club-deal and other funds out there getting it done. Even big firms with the right resouces can pound the pavement, do the research or build the quantitative system that generates returns. Don’t believe me? Read the article (link below) on Apollo, who did more deals in the first part of this year than their three largest competitiors put to work in the same period. Just because the managers you’ve seen thus far haven’t done it, doesn’t mean it isn’t being done.
So before you freak out about one of the topics above and eat an entire red velvet cake while standing at your kitchen counter (no judgement).
Before you decide that you should do away wholesale with your hedge funds, private equity funds, venture capital allocation, financial planner, mutual funds or your dating life.
Take a step back.
Breathe.
Sign off of Match.com because, honestly, any site that thinks the best reason for going on a date with someone is that neither of you smokes needs help with their dating algorithm.
And understand that you’re likely looking only at what you know, which may not help you as much as you’d like.
Sources: HFR, http://www.huffingtonpost.com/2015/04/11/andreesen-women_n_7046740.html, Seward and Kissel, http://fortune.com/2016/08/04/hpe-private-equity-apollo-global-management/
For the last several weeks, I've been watching what I eat. After months of travel and often substituting the contents of my minibar for dinner, I had grown concerned that my bloodstream was permanently clogged with Pringle fragments. So I bought some actual fruits and vegetables (goodbye, scurvy!) and sat down to eat something that didn’t start its life behind a Chipotle counter.
Now, me being me, of course I did my research first, only to discover that I seem to have cognitive dissonance when it comes to portion sizes. I expected that a portion of beef is the literal half-cow that I receive on a plate at Del Frisco’s, when instead it is 3 ounces, smaller than a deck of cards. What. The. Actual. Hell? I felt gypped. I felt bitter. I felt hungry, no make that HANGRY.
But a week later, after sticking to my original plan, I realized I felt full, energetic and, well, maybe even kind of skinny. Maybe the problem wasn't with the reality of eating, but with my perception of what it should be. Hmmmm.
And then I started thinking about investing, and how investors and fund managers seem to be facing similar issues. No, I don’t mean that those pants make y’alls butts look fat. I mean that there seems to be some serious mismatches between what fund managers and investors expect from one another, almost guaranteeing that one (or both sides) will end up disappointed.
So in the spirit of the newly converted (quick, ask me how many calories a banana has!), here are a few ways that investment industry participants can better get along.
Investor Expectation #1: My fund managers should never lose money.
Reality: I’ve said it before and I’ll say it again – Continuous outperformance is a myth. No fund manager walks on water, is always right at the right time, or is even always right. No money manager can control for the unknown unknowns, and occasionally even the known unknowns can bite them in the tushie. The key is not to look for managers who never experience a drawdown (um, let’s remember money manager Bernie Madoff only posted one loss in his career) but for fund managers who can mitigate, manage and learn from losses, as well as be candid and proactive about addressing them.
Money Manager Expectation #1: My fund is AWESOME and yet no one gives me money. Jerks.
Reality: Your fund may be awesome, but if you aren’t getting assets, there has to be a reason. Maybe you don’t have the right network. Maybe you’re not targeting the right investors. Maybe your strategy isn’t in vogue right now. Maybe the investors you’re targeting are fully committed at the moment. Maybe you don’t mind a fair amount of volatility but other folks do. Maybe you have more faith in your simulated track record than others. Maybe you’re just too small/don’t have the right infrastructure at the moment and therefore folks can’t commit meaningful capital. The list of reasons why you’re not getting capital can be endless. Rather than dwelling on how shortsighted investors must be to overlook your fund, perhaps the best use of time would be figuring out why assets aren’t flowing in your direction and developing a plan to address those issues.
Investor Expectation #2: Money managers shouldn’t make money from the management fees.
Reality: While it’s generally accepted these days that a fund’s management fee shouldn’t be a bonanza annuity for any manager, it is also generally accepted (though sometimes forgotten) that running an investment fund takes moola. You have to be able to attract and pay talent a base salary in good times and bad. You need ample staff for your particular investment strategy. You may need research, IT, and other services. You’ve got to keep the lights on, the firewalls up and disaster recovery plans in place. How much this costs depends on strategy, location, number of investors, staffing requirements and a host of other factors. It’s up to the fund managers and investors (during due diligence) to determine a fund’s true “bottom line” and pay fees accordingly. Rarely will they be “zero.”
Money Manager Expectation #2: Investors should have infinite time to talk to me about my fund.
Reality: There are generally eight to 10 hours in an investor’s working day. The investors that I speak to often get 20 to 100 emails and calls a day from fund managers. You start doing the math. Oh, and make sure you factor in committee meetings, travel, PowerPoint presentations, conference calls, HR, compliance tutorials, and bathroom breaks. Now do you understand why it took Issac Investor a few days (or a few emails) to get back to you? Or why they only want to chat for minutes, rather than hours, about your fund? To quote The Karate Kid, “Patience, Daniel-San.”
Investor Expectation #3: There’s only one way to be “institutional.”
Reality: As much as we want a “check the box” solution for fund evaluation, it will never exist. Just because a fund manager has a full time Chief Compliance Officer, Chief Operations Officer, Chief Financial Officer, and Chief Information Officer doesn’t necessarily make that fund better than one that has combined or even outsourced some of those functions. Different levels of staffing and infrastructure will be appropriate at different stages of fund evolution and for different strategies. The key is to determine if key functions are covered adequately, not to count C-Suite professionals in the org chart.
Money Manager Expectation #3: Anyone can be a fund marketer.
Reality: Some folks are great at initiating contact with investors, making a concise and compelling case for a fund, pushing gently for follow up and asking for (and getting) a commitment. Some people aren’t. If you aren’t one of those people (see also, Money Manager Expectation Number 1), even if it is your fund and you know it better than anyone else ever could, you should consider delegating those tasks.
What are your “favorite” expectation/reality gaps between investors and fund managers? Sound off in the comments below while I go eat some celery.
How many times have you sat through a panel presentation at an investment conference only to be bored out of your damn mind by one session or another?
The topic of the session doesn’t matter. It can be a session on anything from the tax treatment of investments to investors writing actual checks to fund managers on stage - investment porn if you will.
Indeed, there is only one thing that can kill a panel discussion faster than Raid kills roaches: overwhelming consensus.
“I agree with the prior panelists that (restate what you’ve just heard).”
“I agree with the prior three panelists that (restate again what you’ve just heard two times already).”
“Bob, do you have anything to add here?” “Well, I actually agree with Pat and Mary and that gentleman in the audience…”
C’mon, you know you’ve been there. And whether you’re in the audience or actually on the conference stage, a part of you wants to pick up a chair, throw it, and start chanting “Jer-ry! Jer-ry! Jer-ry!”
Ok, maybe that’s just me.
Now don’t get me wrong, generally I’m a fan of consensus. Consensus over where to eat dinner, what bottle of wine to order, whether or not a particular outfit makes my butt look big - these are good things on which to have input and universal agreement.
But when it comes to investing, I look for a few renegades, rogues and innovators and prioritize utility over unanimity, potential benefit over style and strategy boxes, because that's where excess value lives.
Last week, Palgrave, the publisher of my 2015 tome Women of the Street: Why Female Money Managers Generate Higher Returns (And How You Can Too), and I launched a Twitter poll. Roughly 130 Tweeters (Twitterers?) responded to the question: “Why do you think gender diversity is important in investing is important?”
This multiple-choice poll offered the following options for answers: Underrepresentation, Higher Returns, Diverse Behavior/Views, and Not Important.
The winning answer (39%) in the poll was “Diverse Behavior/Views”, which was great because that’s essentially my book in a nutshell, and I love the smell of validation in the morning.
I was, however, somewhat stunned that the second most popular answer (30%) was “Not Important.”
Uh, what? How can diverse views and behavior NOT be important in this industry? After all, the investment industry is overwhelmingly Caucasian, male and 35+, and the fund landscape (no matter what the asset class) is dominated by a few large investment firms …and if that ain’t a prime breeding ground for painful consensus, I don’t know what is.
Look, it’s undeniable that some level of consensus is necessary in investing (otherwise you will own a stock, company, bond or other instrument that never increases in value 'cos no one agrees with you about the value), but when we drift towards overwhelming consensus, I believe our ability to make money is diminished. And nothing pisses me off like missing out on returns.
Let’s take venture capital, for example.
- Data from the Martin Prosperity Institute shows that 25.3% of venture capital is invested in San Francisco/San Jose.
- Data from Forbes/Statista shows that 36.2% of venture capital is directed towards software companies, with another 17.3% going into biotechnology.
- And data from PitchBook shows that 45% of venture capitalists with MBAs matriculated from Harvard, Wharton or Stanford.
That's a whole heapin' helpin' of consensus.
To oversimplify a bit, that means you end up with a Venn Diagram of geography, network and industry that looks a lot like the one below, where anything that is overlapping spells some level of competition (higher valuations, similar concepts, etc.).
But start to change even one thing around and you could end up with increased opportunity. What if you look at the same industries and you went to Harvard, but you focus on, I don’t know, the Southeast, for example? Would it make sense that you might find some highly interesting investments that others might not, or are all the good ideas on the coasts? Or maybe you change your network. With so little capital directed to women and minority entrepreneurs, what if you cultivated a different network (or hired people with differentiated networks) to find out-of-the-box opportunities? Could that open up a new avenue for excess returns? The capitalist in me says, “Yes!” Differences can be good.
The same types of things happen in other parts of the investment spectrum, too. I’ve discussed in prior blogs research showing that long-only “benchmark huggers” have less chance of outperformance, (http://www.aboutmjones.com/mjblog/2016/5/3/kicking-the-buckets) and if you think about it, the same should generally be true for hedge funds.
For example, equity hedge funds make up roughly 30% of the overall hedge fund universe by number, and roughly 40% by assets under management. Many of these funds focus on US investment markets, and the vast majority are also managed by white males. This creates a universe of funds that potentially has a similar universe of investment opportunities, similar information available and similar behavior patterns, which can limit outperformance. By modifying one aspect, behavior for example, could we open ourselves up to a differentiated or even higher return? What if we looked at *truly* different strategies? What if…?
Now, don’t get me wrong. I am not anti-anything that generates (or exceeds) my expected return, and the reason that assets tend to concentrate the way they do is that those firms, industries, strategies, etc. often have a history of success.
But as an industry watcher, I can’t help but wonder what kinds of returns would be possible if investors and asset management firms changed their perspective just a bit and took a road less traveled every once in a while. If we wondered less about how much an investment or new hire or strategy looks like past success and instead asked how it is differentiated and could contribute to our overall success. I’m guessing we’d end up with increased diversification, higher returns and a myriad of other tangential benefits, not the least of which is fewer torturous panels.
Sources:http://www.theatlantic.com/technology/archive/2016/01/global-startup-cities-venture-capital/429255/ , http://www.forbes.com/sites/niallmccarthy/2016/06/27/which-industries-attract-the-most-venture-capital-infographic/#4b07db986778, https://pitchbook.com/news/articles/harvard-4-other-schools-make-up-most-mbas-at-pe-vc-firms
With hot weather upon us, more folks out of the office, and a truncated conference schedule, it's easy to get frustrated with the capital raising process. Before you start hating the players *and* the game, make sure you're not committing any capital (raising) crimes and putting your own asset raising efforts in the pokey.
(c) 2016 MJ Alts
It's time for another animated installment of The Hedge Fund Truth! Turn up your speakers, close your door and watch this week's video blog. This video looks at some of the truths and fictions around the hedge fund industry, focusing around recent bad press about returns, fees and a shortage of talent. It asks if the entire industry should be tarred with the same big brush or if there is nuance that investors and industry watchers may not have considered. Are hedge funds inherently BAD for investors, or do we need to gather more data and adjust our thinking? Enjoy!
Please note the MJ Alts blog is now posted on the 1st and 3rd Tuesday of each month.
I was going through some old papers recently and, lo and behold, stumbled across my first grade report card. Since I’ve often struggled with authority figures, I opened it with some trepidation and discovered a few tidbits about the past.
- Much like many employers today, achieving a rating of “outstanding” was impossible by Mrs. Northem’s standards, and is likely the genesis of my overachievement urges.
- Grades were not merely the results of tests and homework, as they became as I got older, but a more nuanced measure of success.
- My teacher (and the ones that followed) seemed to actually like me, with Mrs. Northem writing “Meredith is an absolute joy. She has so much curiosity and interest.”
Now, as one of my friends of course pointed out, the end of that sentence could have been left off. He contends that my teacher merely stopped writing before she added: “She has so much curiosity and interest…that I want to slap her.”
But still.
This little archeological gem made me start thinking about how we grade money managers. We all talk about their collective Grade Point Average (performance) but we tend to get stalled after that.
For example, consider the headlines that of late argue hedge fund managers have generated poor performance, particularly relative to their fees.
What does that mean, exactly?
Let’s assume that means that the average hedge fund has essentially a “C” GPA. If there are five funds (because the math is easy), what grades did each fund make?
- 3 A’s and 2 F’s
- 3 A’s and 2 D’s
- 4 B’s and 1 F
- 5 C’s
- 4 C’s and 1 D
For some reason, financial pundits seem to think the answer has to be either 4 or 5, when, in fact, every combination of the grades above would generate that C average.
While certainly Garrison Keillor can’t be right when he quips “all our children are above average,” it is important to remember that when we talk about average performance some funds, potentially a great many funds, will have performed above that average, while others will have performed below the average. It’s math, y’all.
But before we even get too tied up in our numeric underpants, let’s also consider that the “grades” we give our managers are not as simple as a single performance number.
Just like my reading “grade” was comprised of understanding, reading aloud, attacking new words, interest and writing, in which I earned “D”oes good work across the board (with the exception of writing…I’ve always had the handwriting of a serial killer), how we measure managers is, or should be, comprised of a number of different factors.
- Did the manager perform as expected? Not every manager or strategy will perform well in every market. If, however, the fund performed as we expected given the prevailing market and strategic considerations, that should be taken into consideration. For example, marking down a short seller for not generating eye-popping positive returns during a raging bull market is insanity and a push towards style drift.
- Is the manager taking the risk I expect him to take? If a fund manager starts taking increasing risk with your capital as they chase some illusive performance benchmark, that’s more cause for concern in my book than underperformance.
- Does the manager communicate effectively? Do you have sufficient transparency and frequent updates so you can evaluate how you feel about items 1 and 2?
- How does the manager’s performance fit into my overall portfolio? No fund is an island, but is instead part of an overall asset allocation plan. Managers and strategies should contribute when you expect them to (see above), but again, constant outperformance is more of a myth.
Perhaps because much of the media doesn’t get the full picture, or perhaps because, like me, they’re a bit removed from their old report cards, too many folks become entirely too fixated on manager GPA. Unfortunately, that leads those less familiar with investing to potentially make decisions based on this all-too-linear thinking as well, perhaps even ignoring investments that could have a positive impact on their overall portfolio because they are “bad.”
And that’s really the shame, here. Because if we look behind the manager “grades” we would see that many investors, two-thirds in fact, believe their hedge fund investments actually met or exceeded their expectations in 2015, according to Preqin data.
Which means that either more than half of our industry suffers from the “Lake Woebegone Effect” (all my managers are above average) or there is more to the story than simple average performance.
As someone who “D”id good work with numbers, even back in 1978, I’m betting it’s the latter.
Please note: My blog is now published on the first and third Tuesday of each month.