China FOFs Boom; 10 common mistakes that make smart investment managers look naive And MoreVW Staff
“Remember that the most effective enemy of the market system isn’t some pot-smoking hirsute communistic hippie, but a suit wearing, professional looking, banker or Federal Reserve employee.” – Nassim Nicholas Taleb
Why now might be the right time to look at hedge funds
Forward-thinking investors understand the benefits of rebalancing portfolios ahead of changing market conditions. It is intuitively obvious and yet incredibly difficult. Looking at just the past 20 years, many investors were significantly overweight equities in 1999 and again in 2007, only to endure two massive drawdowns. Few investors want to question why a certain strategy is so successful, much less question when a successful strategy will stop working. Today it's the passive, long-only, daily-liquid products luring investors into a sense of eternal success. Other strategies, including hedge funds, have taken a backseat. So why, then, might now be a smart time to add hedge funds? The key for investors, as always, is to look forward. And while the recent past has been a great environment for long-only risk assets, hedge funds can provide several unique advantages for investors, including the potential for capital preservation, return enhancement and portfolio diversification.
Since World War II, the S&P 500 Index has experienced 10 distinct bear markets, with an average time frame between periods of five years. Our current market rally has persisted now for eight-plus years, making it the second-longest period without a negative 20 percent decline since the Great Depression. The duration of this market rally, combined with historically elevated equity valuations, record-level margin debt and increasing investor complacency, strongly suggest that now is a good time to seek out strategies designed to protect capital in difficult markets. Hedge funds' ability to short stocks and dynamically deploy capital at different points of an economic cycle have enabled them to perform this role in the past. As with capital protection, investors have not faced the need to seek out return enhancement strategies recently, with the S&P 500 generating an annualized return of more than 17 percent since March 2009, compared to its historical rate of return of approximately 9.5 percent. At the same time, the "risk-free rate" (as measured by the three-month US T-Bill rate) has hovered around 1.5 percent since the onset of the Central Bank interventionist policies, compared with a long-term average closer to 3.5 percent. This has resulted in an expansion of the "equity risk premium" from roughly 6 percent to 16 percent, providing significant tailwind to long-only equity exposure.
However, few would argue that these benign market conditions will persist indefinitely. Looking forward, investors should consider not only how to protect their downside but also how to enhance their returns with strategies designed to capitalize on idiosyncratic situations. Smaller hedge fund managers in particular can be more nimble in their investment approach, and specialist funds with sector or geographic expertise, such as long/short technology strategies or Europe-focused, event-driven funds, can offer alpha through their abil-ity to navigate less-efficient markets. A third portfolio-management axiom that has diminished in importance over the past few years has been diversification. Diversification only works when the correlation of securities within and across markets is not structurally elevated. Interestingly, there has been a decrease in cross-asset correlation over the past few months, coinciding with capital flows and monetary policies finally starting to diverge across the globe. Increased exposure to hedge fund strategies designed to balance the risk/return pro-file of multi-asset class portfolios will only increase in value going forward.
China fund-of-funds industry beginning to blossom
China's fund-of-funds industry is set to play an increasingly important role in shaping the country's fledgling hedge fund sector, even as some question how effective a gatekeeper it can be at its own early stage of development. The need for talented gatekeepers is clear. The ranks of China's private "hedge fund" firms — so-called even though only a fraction employs derivatives and futures contracts to hedge — more than doubled to 18,000 since 2013
Evolution of AuM in systematic hedge fund strategies
Current investment areas by systematic managers
10 common mistakes that make smart investment managers look naive
- Using the word "unique" to describe strategy: It would be great if every manager's strategy really were "unique"… but mathematically speaking, it's unlikely. Your strategy might be "different" or even "exceedingly interesting." But with 25,000+ active funds globally, it's hard to imagine that an allocator hasn't seen it all before. No need to fret, though. Your strategy doesn't actually need to be "unique. Your Value Proposition, though, does. Chances are that some aspect or combination of aspects of your business around process, philos-ophy, trade execution, risk management, structure, culture or team really are unique.
- Not taking the time to understand peers: Nothing hurts a manager's credibility more than claiming that "no one else does this" when lots of others do. This goes much deeper than just headline strategy. Shocking how often we hear grandiose statements about a rela-tively pedestrian process or approach to risk management. It may be easy to look past that – but not the statements about comparative strategy correlation or performance. Stuff that a manager can quickly research with an eVestment subscription.
- They let the "me, too" stuff get in the way: Allocators being human, they only can process so much information at one time. If you want your message to be heard, focus on the big points upfront – the two or three messages that you really need them to walk away with. Then push everything else to the back. It's not productive to try and check every box in a first impression. So better to stop trying. Bottom line: say less, not more.
- Confusing "marketing" and "sales": Two distinct activities which are so intertwined that it is easy to misunderstand the difference. But doing so in a business with a long sell-cycle like ours is not a mistake you can afford to make. Simply understanding the difference will make you more effective in your process. "Marketing" is your message, positioning your brand and aligning with your target audience. It encompasses the tools you use and the collateral you develop to communicate that message. "Sales" is the relationship development and personal interactions you have with prospective investors. Sales is about taking your carefully crafted message and putting a voice and personality to it, one-on-one with clients and prospects.
- Not researching the prospective investor before the meeting: Just as you are unique, so is your prospect. Do some homework on the investor before you walk into the room… You wouldn't buy a stock without understanding the opportunity. Same holds true for your approach to preparing to meet a new investor.
- Employing a "sophisticated, systematic and repeatable" investment strategy but an undisciplined and discretionary marketing strategy: Imagine scrapping your entire investment strategy every time a trade doesn't immediately go your way? Just like investing, marketing requires a strategy, consistent execution and commitment.
- Not having a content marketing strategy: You know the joke "How do you know if someone went to Harvard? … They tell you." We all want to be viewed as "smart." But it's not something you can just say. The better approach is to show me how smart you are instead of tell me. Demonstrate your brilliance by becoming a thought leader. One great way to do this is via a content marketing strategy. It en-tails an occasional thought piece, blog post, white paper or even just curating other people's content and then publishing it. Not just on your website, but also on external content platforms like Harvest Exchange or LinkedIn. Sites like these exist as destinations for sharing knowledge and provide access to potential new audiences.
- Playing "hard to get": Even managers that want to be perceived as "hidden gems" are beginning to realize that being found is a LOT harder than it sounds. There are way too many competitors. Being the secretive alchemists hidden in a dark corner is not what it used to be. But… unless you are willing to go "all in" on making your presence known, don't expect a big ROI on a half pregnant marketing strategy.
- Insisting that a web presence is unnecessary (or that an unprofessional looking website is okay): Now you are just being stubborn. The world has changed – accept it. Digital tools really do provide the biggest bang for the buck in shaping perception and disseminating in-formation. Few institutional investors will give you money without ever visiting your office. But… which office will they visit first – your virtual one (your website) or your real one? Too often managers are so caught up in appearance around passing operational due diligence that they fail to realize how hard it is to ever get an investor to come to their office in the first place. Considering the steps an investor is going to take in the overall diligence process, having a weak website or no web presence at all in 2017 is just nuts.
- Blaming compliance for using 20-YEAR-OLD marketing strategies: We are in a highly regulated industry. Restrictions exist on what you communicate, how you communicate, to whom you communicate and when you communicate. No doubt, there is a lot that you are not allowed to do. We get it. But there is also a lot that you can. Many of the biggest managers that target the same institutional investors that you do and have to manage under the same private placement rules that you do seem to understand that. If your GC or CCO is telling you that you cannot use modern, digital tools to communicate, then get a second opinion. Better yet, get a new GC.
Top & bottom 20 funds of 2017
Article by Bruno J. Schneller, CAIA & Miranda Ademaj - Skenderbeg Alternative Investments