Hedge Funds And Alternatives – When There’s Blood In The Streets… by The Attain Alternatives Blog
We always thought it was Jesse Livermore (if you’ve never read Reminiscences of a Stock Operator, pick up a copy) who said this infamous market mantra. But a quick Google search shows it was actually Baron Rothschild, who made a fortune buying into the panic which followed Napolean’s Battle at Waterloo. (As an aside, this was the first instance of high frequency trading, as Rothschild had a carrier pigeon deliver news that Napoleon had been defeated before the rest of London knew; so the quote perhaps should be ‘buy when there’s blood in the streets, and you have an information edge’)
But back to the proverbial blood in the streets… While this is usually a market maxim reserved for traditional investments and related to investments beaten down in price; the contrarian in us can’t help but think there’s some well publicized blood in the streets as it relates to hedge funds and other alternative investments. We’re talking pieces in the Financial Times, Morningstar, Investment News, Wealth Management, and the New York Times. To be fair, as more investors consider these as an alternative to the traditional asset classes, it’s only fair to expect journalists to try and identify and uncover any potholes to avoid.
But while some of these potholes are ones you should avoid, others aren’t really potholes at all. Their choices along your investment journey. Decisions on whether to take this route or that route. To help you make sure you don’t get off on the wrong exit – we’ve highlighted some of these ‘avoid hedge fund’ pieces to help highlight the inaccuracies, potential lapse in detail, or if it is in fact a deserved critique. Enjoy:
Critique: Speculators/Hedge Funds Manipulate the Markets
This one never gets old. Markets move, people freak out, and that’s followed by a bevy of blame computerized Managed Futures and Risk Parity programs unduly influencing the markets. First rule of financial journalism = when in doubt, blame the computers. First up the Financial Times.
This time, Financial Times included to rebuttal to this, making our jobs a little easier.
The above does a good job of explaining that this is mostly hyperbole used to sell newspapers (or digital ads on what used to be newspapers), but we’ll offer a few thoughts here. One, these programs and computer algorithms don’t exist in a vacuum. They are enlisted by investors to generate returns, so the blame can’t be just on the computer-driven strategies – it would be better placed on the investors who enlist the strategies. Two, there are position limits and risk limits in place here. Managed futures and global macro funds are designed to be the fly on the bull or bear’s back, not the bull or bear itself. In technical terms, they don’t seek or want a lot of market impact when putting on/taking off their positions, and will size positions accordingly (and increasingly so – use execution algorithms) so that their movements in positions don’t cause movements in markets. Finally – even if this is all true – can the press play both sides of the equation here, please. We don’t recall hedge funds, managed futures, and Global Macro funds getting a huge thank you from the world for putting pressure on oil prices throughout 2014 and 2015. If we’re the scapegoat when prices go up, why the crickets when prices go down?
Critique: Managed Futures Mutual Funds have Hidden Costs via Swaps
Warranted: Yes, in some cases
Now this is the sort of critique that has merit. For those that aren’t aware, Managed Futures Mutual Funds have exploded over the past couple of years. These structures allow for a lower minimum investment than what were required in the past, but to get the square hedge fund peg into the round mutual fund hole, many of the early mutual fund companies launching managed futures funds did so via the use of a “swap.” This allowed the mutual funds to still be able to pay the sub-advisor’s their typical 2&20 hedge fund fees, which aren’t allowed in the mutual fund world (or at the least would make for an enormous expense ratio). Here’s Morningstar analyst Jason Kephart’s take, via Investment News.
Today, these types of swaps are mostly a relic from when these sort of funds originally launched, thanks in no small part to juggernaut AQR – who chose the less traveled path of direct market access. For example, newer funds Auctos and $IMXIX don’t use swaps. As the lawyers urge you – read the prospectus (or call us) to figure out if the Liquid Alts mutual fund you’re using uses swaps.
Critique: Alternative Investments can be highly correlated with stocks
Warranted: Yes, with one big exception
Here’s a rather big critique which is starting to gain more of a voice – that these alternative investments aren’t all that alternative. WealthManagement.com highlighted this in