|~||~||~|There are many strategies for the modern investor. But are hedge funds really the best way to make cash?
It’s that time of year again. The hedge fund and investment fund conferences are about to hit town. But in a world devoted to the single manager versus multi-manager argument, little mention has been made of the seismic shift in attitudes and stance both from provider and investor. In the flood of new offerings it is all too easy to forget the basic reasoning behind multi-manager funds.
Why invest? The arguments were, and are, clear. Portfolio diversification, lack of correlation to other market areas, access to managers ordinarily beyond the reach of private investors, mean performance averaging out returns over the long term and smoothing volatility. Against such worthy considerations are stacked equally compelling arguments: double charging, no real value added by an additional management layer, poor real returns compared to other hedge fund segments.
Throughout the 1990s, however, the positive arguments seemed to win through and the existing multi manager funds enjoyed a golden age when not only private clients bought in directly but also increasingly, institutions were sold on the idea, either investing on a client’s behalf or frequently with proprietary capital. In an explosive stock market environment, it took little to persuade many to set up their own alternative investment departments and the first step into the water for many proved to be the multi-manager product. Since then, financial institutions answered the siren call of non-traditional investment and there has been an explosion of multi-manager hedge style offerings as marketing departments sought ways to update themselves and to protect their existing distribution bases from poaching.
It is interesting that the very product, (the multi-manager fund), chosen by so many new entrants to the alternative investment arena is the one that arguably has the most difficulties. Surely the rigorous monitoring of perhaps four to five thousand managers, the quantitative and qualitative analysis necessary etc, places urgent demands on anyone.
When imposed upon an organisation with little or no prior experience of managing, even a basic long/short portfolio can produce results that are frequently haphazard.
This headlong rush into the non-traditional arena, selecting 20 to 30 managers from thousands, should inspire caution and concern. The original concept behind the growth in multi- manager funds changed as the few successful ones realised there was a growing institutional market for their product.
As these funds have multiplied, it seems that an institutional marketplace for the fund of funds concept is no longer viable. It is private clients that institutions must now sell their offerings to. Fund of funds turned in the lowest return of any segment appearing continuously in the MAR database throughout the 1990s. So could this be a worrying phenomenon?
In future, significant growth may come from the pension fund sector and insurance groups. Both seek sensible risk adjusted returns but greater than that, they look to iron out market swings.
Recent performance suggests fund of funds fail to answer the volatility problem and rise and fall in tandem with the market. And the financial institutions’ headlong rush to provide pension funds with a cure-all in the shape of a multi manager means multi- strategy products could have dire consequences.
A London Business School study with a sample of 500 hedge funds found little persistence (consistency) of performance over more than two three-month periods. Where it finds consistency, the performance is more likely to be bad than good; the uninitiated may do well to mitigate as much risk as possible.
Looking closely at a market neutral strategy via a diversified multi manager channel is one option. William Sharpe, Nobel Laureate and father of the former industry standard, risk-adjusted return measure said: “I want you to go long the ones you think are really good and short the ones you think are really bad. That means that net-net, you bring me no exposure to growth stocks, or any other stocks … That’s the only kind of active manager I’d ever hire in the best of all worlds.”
A paper by Vikas Agarwal and Narayan Naik investigated hedge fund performance in the 1990s concluded that, “whenever persistence, (among hedge fund managers), is observed it is mainly driven by losers continuing to be losers instead of winners continuing to be winners.”
Stephen Corley is a business consultant.
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