This may sound cynical, but I see Darwinism underway in the hedge fund industry and I’m not sure it’s a bad thing. Maybe there shouldn’t be 6,000 hedge funds.
A good hedge fund manager – in the right strategy – should be able to raise money in nearly any type of market. In the backlash of upheaval, shell-shocked investors hold the cash close to the vest. Inexorably, greed still motivates human behaviour, and memories are short. We should have seen more capital flowing back in by now.
Perhaps it’s because the marketing is still not honest. The $1 trillion of cash or so is still on the sidelines not due to a lack of need; but rather, because investors don’t trust yet. This could be attributable to the following reasons. One, there are more hedge funds than Starbucks on the island of Manhattan, and commission-only incentive arrangements (“third party marketers”) wage aggressive sales campaigns. It’s hard to believe that each of the 6 thousand funds out there is really hedging anything. Two, if we step back and really listen to the things we hear and read in hedge fund marketing materials, I’m not sure I would buy these hedge funds if I were an investor, either.
- A Fund of Funds manager, “We are outsourcing our risk management to ABC Consultant who has recommended buying put options as a way to hedge risk.”
A Fund of Funds is defined as a basket of hedge funds which combine to make low or negative correlation to the market. Shouldn’t the funds themselves be dampening the risk? Once you add options to the equation, you have a structured product and we already lived through that nightmare. Out of the money options are illiquid and hard to value. Option prices are hard to dynamically hedge because linear relationships do not hold well in times of volatility, which is coincidentally when you need the protection the most.
Simplification would be the better way. I’d forget the put option, take a basket of five funds that I knew well, and keep the rest in cash until I was sure to find a few more managers I really liked. By this same logic, there’s nothing wrong with high concentrations; if you like a manager, you should feel confident allocating up to 20% of capital. Conversely, if you aren’t comfortable enough with a manager to invest 20%, you shouldn’t invest a dollar of money.
Long/Short fund, “We envision severe economic headwinds and have taken down risk.”
I’d have a hard time believing in the Coast Guard if I knew that they were afraid of rainstorms.
Event driven fund buys credits which are likely to benefit from improved liquidity.
Liquidity is only there when you do not need it. It is available in accommodative lending markets when the market obeys order. It is the fund manager’s job to make sense of the mayhem and find credits to buy when liquidity is poor.
Long/Short Manager claims good performance was due to “strategic realignment of net exposure.”
Red flag: Many long/short managers do not know how to short so they sell down to cash in bad times. A good shorter loves trading a dislocated market.
“We produce equity-like returns with fixed income volatility.”
This comment is the most hilarious of them all. Although intended to be an aggrandizing statement, it is not, if one were to really think about what this is saying. Equities returned double digit negative performance in 2008 and every major asset class correlated to 1. Why would I want a hedge fund to produce equity returns? I pay a hedge fund manager for hedge fund returns. I’m looking for consistently positive returns, not equity returns. I also do not buy the fixed income comment. Hedge funds did not perform like bonds in 2008, when it would have been great for them to do so.
“2008 was a blip on the radar screen.”
I would honestly have more respect for a manager who says, “the plane took a nose dive for the entire months of September and October.” The traffic cop, heart surgeon, and aeroplane pilot know that they only get one shot. When they get up in the morning, they know they have to get it right the first time. If my heart surgeon messed up and I had to pay bocu bucks to get the mistake fixed over the next 2-3 years, I’d sue him. Why should hedge fund managers who are compensated millions of dollars a year and live in fancy apartments on Park Avenue be held to different standards?
Investors were undeserved, generally speaking, by hedge funds in the recent market cycle. And it’s not evident to me that the industry has stepped up to the plate yet. In May 2010 we saw the same movie: funds down in sync with the market. This leads me to ponder, is anything really being hedged?
Massive redemptions are forcing the fittest to survive. In this fragmented game, the Varsity are the ones getting all the playing time right now. Perhaps the bench should get cut until hedge funds, on average, change their game.
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