Hedge funds see Trump victory as positive for returns: Chart
Q3 2016 hedge fund letters
Get The Full Ray Dalio Series in PDF
Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues
Survey: Hedge fund managers have the best work-life balance in finance
People who work in hedge funds have the best work-life balance in the finance industry, according to a new survey. Around four-fifths of hedge fund managers reported their work-life balance being either great or satisfactory, according to a report from salary-benchmarking site Emolument.com. Hedge fund managers are usually the clients of banks and so are more "flexible in their working arrangements, be-ing in a less pressurised client-driven environment compared to their sell-side counterparts," according to the study, which surveyed 1,360 professionals.
Clients are key to both work-life balance and pay. Advisors on client-intensive mergers and acquisitions have the worst work-life balance, despite the high pay. Meanwhile middle and back office staff in banks earn a fraction of the client-facing employees and still lack a decent work-life balance. "They are more often blamed and rarely congratulated by their front office teams, on top of which they tend to work long hours, tidying up transactions and troubleshoot long after traders have gone home," Emolument said.
How pension plans can build the case for hedge funds
At the beginning, allocating to hedge funds seemed smart and easy. Allocations to a diversifying and non-correlated set of elite investors that could protect against market turmoil and improve long-term performance would be helpful to asset owners and retirement plan sponsors. The high fees would be justified by the performance benefits.
When the thesis faltered — funds underperforming vs. what is now seven years of low yields and rising equity markets, and fees paid exceed-ing value delivered — allocators demanded quick answers. These answers came as a flood of disparate information. Hedge fund managers provided justifications, access and sometimes even increased transparency; consultants offered models and other funds that have done bet-ter; technology vendors offered sophisticated analytical tools.
Buried under a pile of paper and under attack from boards, pension staffers tasked with overseeing hedge fund allocations are wondering where to go from here.
The fact is that, in most cases, there still are good justifications for allocating to hedge funds, but these allocations need to be understood and monitored properly. Hedged assets will generally not outperform a rising equity market with low volatility. Dislocated markets, bear markets, inefficient markets are where hedge funds tend to do best, and these have not been the overall conditions during the slow and fragile recovery starting in 2009. Even so, many funds have outperformed. Unfortunately, unless pension fund officials were shrewd (or lucky) enough to find a set of outperformers, chances are their overall exposure to hedge funds has caused a drag on the portfolio.
There is also reason to believe that walking away from hedge funds now would be like abandoning a hedge because it was too expensive right before the bottom falls out. It is reasonable to expect that global rates will begin to rise in the next year or so, and that equity markets (generally overvalued from a price-to-earnings perspective) should correct. In this case, hedge funds might offer exactly the performance and protection that justified the initial allocation.
More robust portfolio with liquid alternatives
According to Morningstar, the average US equity manager, has underperformed the S&P 500 Index over the past one, three and five years. Given investors natural tendency to chase what's working, and ditch what's not, "the death of active management" is becoming a popular consensus sentiment.
Before writing off active management and jumping on the index fund bandwagon, investors would be well served to pause and reflect. Might this be a cyclical phenomenon? If so, when have we seen this in the past? And most importantly, how did it play out last time? Spoiler alert: yes, this is cyclical; yes, we have seen this in the past; no, it didn't turn out so hot for overvalued indices overweighted in overvalued large caps.
Ed Chancellor's Capital Account provides some historical perspective. For memory-challenged-investors, the book offers a wonderful review of the decade leading up to the tech bubble, via a collection of essays from Marathon Asset Management.
Here are a few excerpts for all you closet indexers out there:
The periods over the last few years when the indices have outperformed active managers have largely been due to distortions cre-ated by the indices themselves, rather than to the alleged superiority of index investments. In fact, the combination of blind capital and arguably flawed index construction is to a great extent responsible for the current problems of the bear market.
By facilitating the TMT bubble and other recent bubbles, indexation has also led to a gross misallocation of resources across econo-mies. Passive investing, in our view, is dumb investing. Shares are bought as companies increase their weighting in the index and are sold when the weighting is reduced.
The consolidation of the asset management industry has exacerbated the problems caused by indexation. This has produced a pro-liferation of large investment firms, commonly managing more than $100 billion in funds. Since they are obliged more or less to own shares relative to their size in the index, these firms have become indistinguishable from passive investors. During the later stages of the bull market, the growth of passive funds and closet-tracking fund management firms . . . created an artificially high de-mand for certain stocks relative to their supply. As a result, these funds benefited from the bubble they created in certain stocks.
A direct consequence of these distortions was the growing obsession of fund managers and the clients with tracking error. As it be-came more difficult to beat distorted indices, active managers decided not to take too much active risk relative to the benchmark. With more and more money invested in this way, a Ponzi scheme developed. This led to the ultimate disaster for passive investors. In the twelve months after March 2000, the largest, supposedly least risk, and widely owned shares collapsed relative to the market. The ten largest companies, which then accounted for some 27% of the index, underperformed the market by a stagger-ing 23.5%.
Once passive investing starts to distort the pricing mechanism, the ultimate result is the underperformance of the original benefi-ciaries of that distortion. The future performance of any investment practice is significantly altered once it has been widely imi-tated. This is what happened to index investing.
A common question put to professional investors during the bubble was, "why do I need an active manager when the index can be bought for a nickel?" Some three years later, the answer is clear.
We are once again, beginning to hear that question today. And once again, we think the answer will be clear "some years" later. Passive in-vestors typically look brilliant in the late stages of a bull market. They are looking awfully smart today, particularly relative to more disci-plined investors who are inclined to avoid the overvalued businesses driving most of the market's gains. The proliferation of index funds drove the 90's tech bubble and ultimately, it's collapse. If you thought that was painful, wait until you get a glimpse of the hangover around the corner from the Blind Capital piling into ETFs.
Differences in hedge fund performance widen gap in portfolio manager pay
Article by Skenderbeg Alternative Investments
See the full PDF below.