Hedge funds – Put into perspective by Skenderbeg Alternative Investments
“Economists are people who look at reality, and wonder whether it would work in theory.” – Ronald Reagan
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2017 total alpha outpaces prior 7 years through July
July was good for hedge funds
Hedge funds gained in July, notching their strongest monthly performance since January, ThinkAdvisor reports, citing data from Hedge Fund Research Inc. Key drivers were emerging markets, equity hedge, technology and health care. The HFRI Fund Weighted Composite Index in-creased 1.2 percent last month, ThinkAdvisor notes. That's the ninth straight positive month and the 16th out of the trailing 17. So far, this year, the index is up 4.8 percent. The emerging-market sub-index jumped 3.6 percent in July, its best performance in 16 months, according to ThinkAdvisor. The sub-index is up 13.5 percent for the year.
Elsewhere, the equity hedge sub-index increased 1.7 percent last month, boosting its year-to-date performance to 7.7 percent and topping its full-year returns for each of the past three calendar years, the publication reports. Technology and fundamental growth sub-strategies were the biggest drivers of equity hedge performance in July. Total hedge fund assets grew to $3.1 trillion by the end of the first half of 2017, as the industry saw its first net capital inflows since the third quarter of 2015, ThinkAdvisor notes, citing Hedge Fund Research.
eVestment: Hedge fund industry inflows +$20.65B in first half
Investor sentiment seems to be broadly catching up with improved investment performance, as capital flows to the hedge fund industry were positive in both second quarter and first half of 2017. However, June's flows were negative again, notes industry data provider eVest-ment, raising questions about whether the shift in trend has staying power.
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Machines taking over hedge funds despite lack of evidence they outperform humans
- Data science may be a big part of the comeback story.
- Credit Suisse mid-year survey says 81 percent of investors likely to put money in hedge funds during the second half of 2017.
- About 60 percent of those investors are planning to increase allocations to quantitatively focused strategies over the next three to five years
Hedge funds turn to dark web to gain an edge
In the race for new data to better inform investment decisions, hedge funds have scraped Twitter, logged Amazon reviews, and monitored satellite images of oil tankers. Now they are turning to a more controversial resource: the dark web. Access to the dark web is one service being offered by business intelligence experts to hedge funds, according to a number of people familiar with the providers. These experts specialize in doing deep dives into businesses and the people who run them. Typically associated with drug and weapons sales and terrorism, the dark web is a series of websites accessed only through an encrypted network, which provides anonymity to its users. And it is these shady activities which make it so useful to the hedge fund industry, experts say.
While accessing the dark web is not illegal in either the UK or US, using it as a resource in investment decision making marks a departure from the use of open source alternative data, such as social media and satellite images, which have exploded in use by hedge funds in the last few years. Some in the investigations market say its use by hedge funds could be more difficult to justify to investors. "The dark web is not open data," said an investigative researcher who said he had largely stopped working with hedge funds as the regulatory restrictions were too hard to navigate. He added that the anonymous nature of the dark web made it difficult for hedge funds to be sure they were not inadvertently accessing insider information or information that had been stolen from the company. Another analyst said: "Hedge funds are spending vast amounts to get information as their work is basically a bet on their information being better than others. There are small inves-tigators pushing the ethical and legal limits as close to the line as possible." But a former analyst at Kroll, a $1bn corporate investigations firm, waved away any suggestion that accessing the dark web as a corporate service presented an ethical challenge. "If you're using it as a way to garner information and to warn people away from organizations then there's nothing particularly dodgy about that," he said.
The majority of hedge fund investors are institutionals like endowments and pension funds
Cost of liquidity – The hidden management fee that needs to be calculated
Investors are looking closely at the fees being charged, but the hidden fee of liquidity may be the most significant cost that is often not talked about. Large firms that are charging less may have higher costs associated with liquidity than small firms. As the size of the firm grows, the cost of entering and exiting may be higher. Additionally, some markets that may offer opportunities are avoided because the cost of trading when liquidity is lower is higher. There are economies of scale for managing a hedge fund business as a firm grows, but there are potential diseconomies of scale associated with the investment management of the business. You may get firms to be much more competitive on price as the assets under management grow or as it prices a large new inflow, but there may also be higher investment costs with running the money. One way to combat this higher liquidity cost is to increase expenditure and resources on trading and execution algorithms.
As firms get larger or price based solely as a management fee there may be the potential for misalignment of incentives and hidden perfor-mance costs. Larger firms that have covered fixed costs could easily focus more on incentive fees but it seems merely likely they will cut in-centives and actually skew toward locking in management fees. There is a trade-off between the benefits from scale through risk manage-ment, research, execution, and business cost savings against the costs of liquidity management. There will be a point where the added net return from scale is outweighed by the performance drag from liquidity shortages. Nevertheless, the cost of liquidity is extremely hard to measure because when you need it, it will not be available. The inflection point between economies and diseconomies of scale is hard to determine. So a natural question is, "What is the capacity of any given firm?" and "What is the capacity for a given strategy or across all firms pursuing the same strategy?" It is surprising that more firms have not closed to new investments as they have grown. It is likely most firms are optimistic and gauge capacity on the high side. Additionally, back of the envelope calculations on trading across firms suggest that many trades can easily be considered crowded. Discounting the uncertainty of liquidity is more important than calculating the discount or savings from lower management fees.
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