Hedge Funds – Put Into Perspective by Skenderbeg Alternative Investments
“Forecasts usually tell us more of the forecaster than of the future.” – Warren Buffett
Deutsche Bank survey says investors optimistic on hedge fund performance
Deutsche Bank's recent survey of hedge fund industry investors found they were optimistic, according to Barry Bausano, the bank's presi-dent of securities: "The number of people who are expecting to maintain or add to their hedge fund exposure was 90 percent this year versus 84 percent last year." Bausano said the Trump administration's plans for deregulation will be good for the market, but it will take time for them to have a nominal effect. He said the main things for investors are to make sure they have the right guidance through the economic and political changes. "It's always been important to select the best strategy but now to a greater extent than ever, getting the right manager within the right strategy has been key," Bausano said.
Hedge funds run by women outperform
Hedge funds run by women have outperformed a broader benchmark of alternative investment managers over the past five years, raising fresh questions about why there are so few female portfolio managers. The HFRI Women index has returned 4.4 per cent over the past five years, compared with a 4.2 per cent return for the HFRI Fund Weighted Composite index, a broader gauge of hedge funds across all strategies and genders. The figures support research by Roth-stein Kass, the accounting firm, in 2012 and earlier academic studies that found hedge funds run by women outperform those managed by men. Nonetheless the number of women in the indus-try remains small, with fewer than one in 20 hedge funds employing a female portfolio manager, according to a 2015 study by Boston's Northeastern University. By contrast, one in five mutual funds employ a female portfolio manager, according to Morningstar, the data provider.
Jane Buchan, chief executive of Paamco, a $24bn fund of hedge funds, said the lack of female hedge fund managers stems from the prob-lems women face when trying to raise money from investors. She said: "Women [hedge fund managers] have substantially less assets. That is a real issue, and it is not a performance issue. It is hard to win the money.""To get that same [level of assets as a man], you have to [outperform by] 200 basis points." KPMG, the accounting firm that acquired Rothstein Kass in 2014, last year found 79 per cent of US hedge fund professionals believe it is harder for women to attract capital from investors than for their male counterparts.The disparity between the number of men and women working in the industry is one of the highest in finance, the Northeastern study found. It found that only 439 hedge funds employ a female portfolio manager, compared with 9,081 that employ a male investment manager. When expanded to include women in marketing, compliance and administration roles, female representation at hedge fund companies rose to 21.5 per cent.
Because it is harder for women to raise assets when they do branch out on their own, the funds that thrive are ones that tend to outper-form, according to the Northeastern research, which was published last year in the Review of Financial Economics. Although the latest statistics indicate female hedge fund managers outperform over the long term, last year they underperformed the broader hedge fund index significantly. The HFRI Women index was up 2.2 per cent last year, compared with a 5.5 per cent return for the HFRI Fund Weighted Composite index.
Hedge fund managerial talent: From quality to quantity
A new report that comes to us jointly from EY and the AIMA indicates that hedge fund industry leaders believe that one of the secrets to success in the field is investment in, and thus retention of, talent.
When the report was released, Dan Thompson, partner in the EY financial services practice, explained its findings this way: "It seems that for a hedge fund, as much as any business, success is in large part driven by articulating a clear message in advance, delivering what you have promised, and doing so reliably over time. This applies to relationships with both investors and staff."
In terms of the relationship with the staff, one crucial component not surprisingly turns out to be the hedge fund's internal compensation systems. The EY/AIMA report, Traits of Success, says that misalignment "between the remuneration of investment and non-investment staff at [a hedge fund] firm is likely to be harmful to team cohesion." This insight produces something of a dilemma: collective incentives for good performance may be conducive to the necessary team spirit when times are good, but they may be excessively punitive when timers get rocky, for the market or for a particular strategy and attendant funds.
More generally considering questions about investing in talent encouraged us at AAA to look again at a November 2015 paper from Georgetown McDonough School of Business, Managerial Talent and Hedge Fund Performance, which sought to quantify the significance of management skill.
The authors of the Georgetown study were: Turan G. Bali, Stephen Brown, and Mustafa Onur Caglayan. They looked at maximum monthly returns for hedge funds over given time intervals (MAX). After controlling for the four Fama-French-Carhart factors they found a significant remaining return spread between the high-MAX and low-MAX and they tested whether that is a predictor of superior fund performance in the future.
The method seems analogous to that employed by Sherlock Holmes, as chronicled by Arthur Conan Doyle in The Sign of the Four, "once you have eliminated the impossible, whatever remains, no matter how improbable, must be the truth." Once one has eliminated all other known factors via statistical legerdemain, whatever remains must be managerial talent, especially if this hypothesis has predictive power.
Intriguingly, Bali et al also found that "for hedge funds with no derivatives and low leverage usage, the next month return and alpha differ-ences between high-MAX and low-MAX funds are not significant, while the return/alpha spreads are positive and highly significant for funds with high leverage and derivatives usage." So under those specified conditions (absence of derivatives or leverage) the talent spread, so to speak, effectively disappears. What is the talent doing that the less talented can't do? Evidently it involves making good use of derivatives and debt.
Back to the '80s
Talent matters for performance, for survival, and for inflow. Further, MAX as a measure of such talent "can be effectively used by investors when selecting individual hedge funds."
This fact sent Bali et al back to a 1981 study in which Roy D. Henriksson and Robert C. Merton contended (in the Georgetown group's para-phrase) that "directional funds willingly take direct exposure to financial and macroeconomic risk factors, relying on their market and macro-timing ability to generate superior returns." In two papers in The Journal of Business Henriksson and Merton set out a market timing model designed to allow identification of the gains generated for a portfolio by market timing skills even if the timer's forecasts are not observable by the analyst.
The Bali findings are consistent with the older Henriksson-Merton model. To test further the connections involved, the Georgetown group ran a market-timing skills test at the fund level. It found that "the next month return