Sep. 2015

Darwin, Hedge Funds, Liquid Alts, and the Opportunity from August 2015

The coldest winter of my life was the summer of 2015 investing in hedge funds. I have relied on Mark Twain’s famed words, to make a point.

If your fund was positive for August, or near breakeven, congratulations. You did your job.

Bad, uninformed asset owners who lack investment process, and invested with the wrong managers, many of them big names, lost money in August when they discovered the shocking truth – that their hedged investments were actually not hedged.

There is a relatively small number of truly great managers out there. Trends and trades are crowded. Few understand alpha and how to achieve it. Even fewer comprehend how to balance risk, and how to garner the mandate from their investors to deliver outsized returns. So many funds now are fixed income replacements that promise low volatility, steady returns and are using faulty risk assumptions that can work, until they don’t.

Bad performance and the shock of what happens in volatile markets are a good thing. The meritocracy of bad performance is more potent than that of good performance. Times such as these, with our current markets, help to separate the talented from the lucky, and the scalable investment processes from those with math based on incorrect premises.

The industry needs these shakeouts to reduce the number of managers, and through the Darwinian process, allow the strong to survive and gain more traction, assets, as well as the fees that go along with it.

Two questions that I ask are: Why would anyone pay 2 and 20 for not being hedged? Will this time really be different?

Unfortunately, the institutionalization of the business bifurcates and waters down the pure Darwin process. Some very large funds that under-deliver or lose ground will maintain their investors through sheer size, inertia and promises of fixing the “short-term bump” that was August of 2015. This is occurring with liquid Alternative 40 Act Mutual Funds as well. This ultimately hurts the industry. As firms become too large, they can lose their ability to deliver their original edge across so many investors and with such large AUM.

There is a perception that there is huge money to be made running a hedge fund. The reality is that of the about 10,000 funds, most are under $100 million in assets. The reality is that between operating, compliance, office, employee and data expenses, most are not getting rich.

Truthfully, many of these “emerging managers” are fooling themselves. One needs to be north of $200 million to be really making a good living in this business, and much more to be “getting rich” as a manager. To be worthy of this level of AUM, judge how you performed in August, and the last month the markets melted up. Are you really delivering what you promised? Performance during the big moves is what separates the average from the talented.

The time has come for managers with talent, expertise and now the experience of making money in “interesting times” to have their voice heard.

As a former manager who raised his fund to profitability, and created diversified products and distribution channels, I grow weary when I hear about how hard it is to raise assets, and how this unfortunate event will only create an advantage for the bigger funds.

This is simply inaccurate. Have the intellectual honesty to know if you are an average manager (and go get a job), or if you are exceptional, and deserve to have a solid place where asset owners and investors should trust and pay you to make money in all market environments. If you have real talent, raising assets is not an unattainable goal. Profiting in both up and down years is what earns that opportunity. Having a real voice can be a challenge. Today, there is an industry that supports talented managers. Reach out.


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