Excusa-paloosa: The Sad Excuses We Give To Avoid Small Funds & Gender Diversity

I am no stranger to making lame excuses. Just last week, in the throes of a bad case of the flu, I managed to justify not only the eating of strawberry pop-tarts and Top Ramen but also the viewing of at least one episode of “Friday Night Lights.” It’s nice to know that when the chips are down at my house, I turn into caricature of a trailer park redneck. 

But in between bouts of coughing and episodes of Judge Judy, however, I did manage to get some work done. And perhaps it was hyper-vigilance about my own excuse making that made me particularly sensitive to the contrivances of others, but it certainly seemed like a doozy of a week for rationalizations. Particularly when it came to fund diversity in nearly every sense of the term, but particularly when it came to investing in women and/or small funds.

So without further ado (and hopefully with no further flu-induced ah-choo!), here were my two favorite pretexts from last week.

Excusa-Palooza Doozie #1 – “We want to hire diverse candidates, but we can’t find them.”

In an interview with Fortune magazine, Marc Andreessen, head of Andreessen Horowitz said that he had tried to hire a female general partner five whole times, but that “she had turned him down.”

Now c’mon, Mr. Andreessen. You can’t possible be saying that there is only one qualified female venture capital GP candidate in the entire free world? I know that women only comprise about 8-10% of current venture capital executives but unless there are only 100 total VC industry participants, that still doesn’t reduce down to one. Andreessen Horowitz has within its own confines 52% female employees, and none of them are promotable? If that’s true, you need a new head of recruiting. Or a new career development program. Or both. 

But it seems that Andreessen isn’t entirely alone in casting a very narrow net when it comes to adding diversity. A late-March Reuters piece also noted that they best way to get tapped to join a board as a woman was to already be on a board. One female board member interviewed had received 18 invitations to join boards over 24 months alone.

It seems the criteria used to recruit women (and, to some extent, minority) candidates into high-level positions are perhaps a bit too restrictive. In fact, maybe this isn’t a “pipeline” problem like we’ve been led to believe. Maybe it’s instead more of a tunnel vision issue.

So, as always happy to offer unsolicited advice, let me put on my peanut gallery hat. If you genuinely want to add diversity to your investment staff, here are some good places to look:

• Conferences – The National Association of Securities Professionals, RG Associates, The Women’s Private Equity Summit, Opal’s Emerging Manager events, the CFA Society, Morningstar and other organizations are all now conducing events geared towards women and minority investing. Look at the brochures and identify candidates. Better yet, actually attend the conference and see what all the hubbub is about, bub. 
• Word of mouth – I have to wonder if Andreessen asked the female GP candidate on any of his recruitment attempts if she knew anyone else she could recommend. If not, shame on him. Our industry is built in large part on networking. We network for deals, investors, service providers, market intelligence, recruiting, job hunting, etc. We are masters of the network (or we should be) and so it seems reasonable that networking would be a fall back position for anyone seeking talent. And if Andreessen did ask and was not given suitable introductions to alternate candidates, shame on the “unnamed woman general partner.” 
• Recruiters – Given the growing body of evidence that shows diversity is good for investors, it’s perhaps no surprise that there are now at least two recruiters who specialize in diversity candidates within the investment industry. Let them do the legwork for you for board members, investment professionals and the like.
• Service providers – Want a bead on a diverse CFO/CCO – call your fund auditor. Looking for investment staff? Call your prime broker or legal counsel. Your service providers see lots of folks come in and out of their doors. Funds that didn’t quite achieve lift off, people who are looking for a change, etc. – chances are your service providers have seen them all and know where the bodies are buried. Don’t be afraid to ask them for referrals.

Excusa-Palooza Doozie #2 – See?!? Investors are allocating to “small” hedge funds! In a second article guaranteed to get both my fever and my dander up, we were treated to an incredibly optimistic turn of asset flow events. It turns out that “small” hedge funds took in roughly half of capital inflows in 2014, up from 37% in 2013 per the WSJ.

Now before you break out the champagne, let me do a little clarification for you.

Hedge funds with $5 billion or more took in half of all asset flows.

Everything that wasn’t in the $5 billion club was termed “small” and was the recipient of the other half of the asset inflows.

It would have been interesting to see how that broke down between funds with $1 billion to $5 billion and everyone else. We already know from industry-watchers HFR (who provided the WSJ figures) that 89% of assets went to funds with more than $1 billion under management. We also already know that there are only 500 or so hedge funds with more than $1 billion under management. So really, when you put the pieces together, aren’t we really saying that hedge funds with $5 billion or more got 50% of the asset flows, hedge funds with $1 billion to $5 billion got 39% of the remaining asset flows, and that truly “small”  and, well, "small-ish" hedge funds got 11% in asset flows?

I mean, for a hedge fund to be termed “small” wouldn’t it have to be below the industry’s median size? With only 500 hedge funds at $1 billion or more and 9,500 hedge funds below that size, it seems not only highly unlikely but also mathematically impossible that the median hedge fund size is $5 billion. Or $1 billion. In fact, the last time I calculated the median size of a hedge fund (back in June 2011 for Barclays Capital) it was - wait for it, wait for it - $181 million.

And I’m betting you already know how much in asset flows went to managers under that median figure…somewhere just slightly north of bupkis. And the day that hedge funds under $200 million get half of the asset flows, I will hula hoop on the floor of the New York Stock Exchange. 

So let’s do us all a favor and stop making excuses and start making actual changes. Otherwise, we’re leaving money and progress on the table, y’all. 

Sources: WSJ, HFR, BarclaysCapital, Reuters, Huffington Post

Are Hedge Clippers Trimming Up The Wrong Tree?

Generally speaking, I try to stay away from any public commentary about politics. However, recent activity by the “Hedge Clippers” is becoming increasingly difficult to ignore, especially now that they have started showing up at personal residences (Paul Tudor Jones) and hedge fund conferences. Just yesterday, the Hedge Clippers burst into a 400-person investment conference (the 13D Monitor’s Active-Passive Investor Summit) to protest fast food workers wages. In fact, it will be interesting to see if the Clippers get, well, SALT-y next month, donchathink?

Now, before I continue, let me just say this: I get it. As the daughter of a single mother who worked in secondary and higher education all her working life, I extremely well equipped to see both sides of the socio-economic coin. Our society isn’t perfect and people are pissed. Post-2008 this ire has often and increasingly been directed at Wall Street. In recent months, however, anger seems to have coalesced around a single boogeyman: the hedge fund manager. And I just have to wonder: Is all that ire deserved or are hedgies just the easiest targets?

One of the biggest complaints of the Hedge Clippers is that hedge fund managers are “buying” politicians through heavy donations to political candidates. We do know that many in the financial industry take an interest in politics, but I thought it would be interesting to actually look at the top 100 political donors for 2014 and see what the numbers actually looked like. While there were certainly hedge funds that made the list, it may surprise the Hedge Clippers and others to know the facts behinds hedge funds and politics.

Out of the top 100 federal political donors in 2014, a mere 14 (that’s 14% for those of you playing along at home) were hedge fund managers. Perhaps more interestingly, of those 14 politically-minded hedge funds, a full 50% of them gave 100 percent of their donations to Democrat or Liberal candidates, while the other 50% primarily donated to Republican or Conservative candidates. That’s probably a lot more balanced than most folks would have expected.

In fact, if you want to get angry at folks just because they give large sums of money to political candidates, you should probably boycott films like The Help, Lincoln, Shrek and Cast Away because Dreamworks made the list of top 100 political donors. And don’t move, store or mail anything either: Uline was in the top 10 political donors for 2014. Maybe the Hedge Clippers should find new groups to help spread their message. I recommend these groups be called the Dream Killers and the Box Cutters, respectively.

However, yesterday’s protest beef centered primarily around minimum wage requirements for fast food workers. With chants of “Show us $15!” the Hedge Clippers are angry that “A group of activist investors are behind the big expansions in franchising at fast-food restaurants that have netted hundreds of millions in profits for hedge funds.”

And it’s that phrasing that kind of butters my toast. While a hedge fund is a profit-driven enterprise, they generally take a relatively small percentage (20%) of those profits. The rest of the returns go to end investors for whom the hedge funds act as fiduciaries.

Fiduciary responsibility means, at least in part, that the fund manager has a responsibility to act in the best interest of his or her investors, including, but not limited to doing things like behaving in an ethical way and making decisions to protect (and in the case of an asset manager) grow the assets of the firm. Perhaps the case Bristol and West Building Society v Mothew summed it up best when it concluded: “A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.”

And that’s interesting to note, since many pension plans, including teachers' pensions who have been early supporters of the Clippers, are investors in hedge funds. They are among the very beneficiaries of hedge funds who “extract maximum profits” through the use of activism and other hedge fund strategies. Neat, huh? In fact, not making “maximum profits” is often enough to trigger a redemption request.

Perhaps if the Hedge Clippers really want to enact change, they shouldn’t start with the people who have a fiduciary responsibility to generate profits for their end investors. Maybe they should start lobbying and educating end-investors about things like Socially Responsible or ESG Investing. In this particular fiduciary relationship, the bond of trust is not only to achieve returns, but to have an environmental, social or governance or other positive impact at the same time.

And the sustainable and responsible investment movement is definitely on the rise, growing 76% between 2012 and 2014. Unfortunately, interest in this space still has a ways to go. In a survey of the mass affluent conducted by Spectrem, social responsibility ranked dead last in importance in the investment selection process.  For those 64 and up (who perhaps not surprisingly have the highest mean wealth), when ranking on a scale between 0 and 100, scored socially responsible investing at a mere 30.7.

But looking ahead, the Hedge Clippers have something to be happy about. The mass affluent under 49 years old rated their interest in socially responsible investing at nearly 50, so the times they will be a-changing, and millennials are even more interested in impact investing. Over time, that interest in ESG will have more of an impact on investment options and strategies.  Until there is more of a wealth transfer, however, perhaps it’s better for groups like the Hedge Clippers to put pressure on the folks that really call the shots in our industry: Investors. 

Sources: CNBC, Policyshop, Millionaire Corner, Inc. Magazine, Hedgeclippers.org, OpenSecrets.org

7 Secrets to a Successful Fund "Elevator Pitch"

Regular readers of my blog know that periodically I offer completely unsolicited fund marketing advice. Given that we are in the midst of a busy conference season, I thought it wise to focus this week's peanut gallery on the elevator pitch. If you've been to many conferences in any capacity, you've had the opportunity to witness the elevator pitch in all of its flavors - the good, the bad, and the practically sociopathic. You may have even been asked (out loud or with just a frantic glance across a crowded cocktail party) to aid and abet the escape from an elevator pitch gone wrong. 

To protect conference goers everywhere from the out-of-control elevator pitch, I've created the following infographic to help bring cosmos to the pitching chaos. I hope the advice will help your next asset raising encounter or at least make a colorful liner for your trash bin. As always, may the pitch be with you.

(c) MJ Alternative Investment Research LLC

It's "Showtime" For Hedge Funds: An Open Letter to TV Execs

Dear Showtime Execs, 

I read with great interest (and no small amount of trepidation) about your plans to create a new series based on the hedge fund industry. As I understand it, “Billions” will be based on the interactions of a high finance hedge fund manager (Bobby “Axe” Axelrod) and US Attorney Chuck Rhoades played by character-actor everyman, Paul Giamatti.

As you begin filming, I would like to take a moment to point you towards some of the scintillating “real life” hedge fund moments the series should capture.

1)   Most billion-dollar hedge fund managers are named John or David (16 total), with names like William, Kenneth, Robert, James or Paul close seconds. After 17 years in the hedge fund industry, I have yet to meet anyone that goes by a moniker like “Axe.” My guess is that in today’s more institutional climate, a nickname like that would be an impediment to raising assets and would be discontinued either by the manager or discouraged by the compliance department. A name like Axe is like speeding in a red sports car. You may be ok, but chances are you’ll attract the wrong kind of attention.

2)   Despite the inference that hedge funds frequently engage in insider trading, the actual practice appears to be pretty limited. There are an average of 50 insider trading cases each year, and even if all of them were centered on hedge funds (they aren’t), the percent of hedge funds that engage in nefarious scams and rip-offs is, in fact, tiny. Assuming all 50 insider trading scams were perpetrated by hedge funds each year, that would comprise less than 0.05% of the industry. Perhaps it would be better to focus on things of which hedge funds are more routinely guilty. Maybe Giamatti can focus on investigating bad pitch books, using conference speaking opportunities to pitch product, or maybe even strategy drift?

3)   Oh, and when you send “Axe” to an industry event, try to limit the amount of hookers you cast and the amount of illegal drugs you showcase. Most events these days start at 8:00 am continue through cocktails at 6 to 7pm. At cocktail parties there are regularly a shortage of bartenders, making getting a drink a time consuming and sometimes almost Herculean task. As a result, alcohol consumption can be fairly self-limiting.  After cocktails there are inevitably investor or service provider dinners, which, given the number of invited diners and courses, can easily add an additional three hours to your day. Since many of these dinners are hosted at long tables in private dining rooms, you can be sure that there will be limited opportunities to interact with others. Be sure you like the folks sitting either directly next to or in front of you or it will feel like an even longer night. There will be one or two obligatory toasts from the hosts. People will check their email under the table throughout. It’s truly a bacchanal.

Of course, there are some event-goers that still have the energy for extracurricular activities after that long working day, and these activities are primarily dependent on the location of the event. At the largest industry event, SALT, you’ll usually find a good live band playing after hours, and, since it is in Las Vegas, you will definitely find some attendees at the Blackjack tables. I have heard of a few attendees winning up to 10 grand. There may be some hookups, but I honestly haven’t seen any Hangover-type antics of late.

In fact, I’ve attended more than 300 conferences during my hedge fund tenure and I’ve yet to witness much debauchery, other than an emergency call one night to inquire if I had any handcuff keys. (For the record, I did not.)

I do, however, see some serious caffeine abuse, so scenes with hotel staff frantically filling coffee urns and/or attendees complaining about the lack of mid-day refreshment would be good. Sugar and caffeine are probably the most common form of “drug” abuse.

There is also a lot of looking for other people (trying to meet prospects you don’t know, one-on-one meetings, fellow panelists, etc.) so include some random time wandering around looking at nametags. Since those are often on lanyards, if you want a hint of lewd make sure those nametags are displayed right around crotch level – most conference organizers do.

You’ll also want to capture people making off with the good conference tchotchkes – a scene with a mild-mannered manager with his pockets (or oh-so-masculine conference tote bag) filled with golf balls and a stuffed flying monkey for his kids should work.

4)   You should also focus a great deal on the business and operational side of running a hedge fund. Make sure you film people watching mandatory HR harassment training, having to get multiple sign offs just to get a monthly letter out the door, filling in performance numbers on 6-8 hedge fund databases every month, trying to come up with some pithy market commentary, taking and maintaining the Series 7, 24 and 63 exams, meetings with services providers and pestering the fund’s auditor for K-1s and financial statements. Oh, and include folks updating SEC filings - that stuff makes for SEXY television.

5)   You’ll want to include investor meetings in the show, and to get as close to real life as possible, you can probably reuse this footage often. Most initial meetings are “get to know you walk through the pitch book meetings” and meetings after that may focus on an array of due diligence questions that become pretty routine after a while. To change it up, change up the food periodically. Or perhaps have an operational due diligence meeting featuring the CFO and CCO. Since it usually takes 6-12 months or more to secure an investment, make sure you showcase LOTS of meetings.

6)   Since a billion dollar fund isn’t a typical hedge fund (see last week’s blog post on that topic), you may want to introduce some secondary characters that represent the average hedge fund. They should work in 1-3 person shops, and spend most of their time looking at investment opportunities and trying to find investors. They probably make about as much as a well-paid doctor, so their lifestyle should be reflected as such.

7)   I wouldn’t spend too much time focusing on wardrobe for the series. Most hedge fund managers wear a fairly ubiquitous grey, blue or black suit, unless they hail from across the pond in which case you can add some kicky socks to the ensemble. And you’re just as likely to find managers in button-downs or golf shirts with khakis as you are in a power suit, especially within the confines of their offices.

Now, Showtime, I know this is not what you want to hear, but the fact is the hedge fund industry has very different street cred from its relatively mundane reality. Does that mean there aren’t scandals and good stories? Of course not. Any hedgie, including me, who has been in the business long enough can give you stories that are frankly too weird not to be true. But most of the “good stuff” happened in the earlier days of the industry, and even then it was the exception and not the rule. So while you’re focused on getting a great show together, it would be great if you could focus not just on sensationalism but also on truth.

Yours truly,

MJ

Fun with Dots! Visualizing Trends in the Hedge Fund Industry

When most people think about math, they don’t necessarily think about visual aids. They think about numbers. They think about symbols. They may even think, “Oh crap, I hated math in high school.” Even if you are in the last camp, read on. I promise what follows is painless, although you may be tested on it later.

A lot of times, what’s problematic for people about math is that picturing and therefore connecting with what we’re talking about, particularly when dealing with large numbers, can be difficult. For example, I talk endlessly about the inequities in the hedge fund industry, and yet while some folks hear it, I’m not sure how many people “get it.” So today, we’re going to “connect the dots” to visualize what is going on in hedge fund land.

First, meet The Dot Fund, LLC. 

•  

This dot represents a single, average hedge fund. The fund probably has a pitch book that states its competitive advantage is its "fundamental bottoms up research." This makes me want to shake the Dot Fund. But I digress.

Now, most folks estimate that the hedge fund universe contains 10,000 funds, so here are 10,000 dots. Each smaller square is 10 dots by 10 dots, for a total of 100 dots, and there are 10 rows of 10 squares. Y’all can count them if you want to – I did and gave myself a wicked migraine – but this giant square of dots is pretty representative of the total size of the hedge fund universe.

The Hedge Fund Universe

Of course, the hedge fund universe isn’t as homogenous as my rows of dots, so let’s look at some of the sub-categories of funds. The blue dots below represent the “Billion Dollar Club” hedge funds within the universe. That is not a ton of dots.

The Billion Dollar Club Hedge Funds

And here are the Emerging Managers, as defined by many pension and institutional investors as having less than $1 billion in assets under management. Note: That’s a helluva lot of blue dots.

Institutionally Defined “Emerging Managers”

This is the universe of managers with less than $100 million under management, or what I would call the “honestly emerging managers.”

Managers With Less Than $100m AUM

This dot matrix represents the average number of hedge funds that close in any given year. It doesn’t look quite as dire as the numbers do in print...

Annual Hedge Fund Closures

Finally, here are the women (stereotypically in pink) and minority owned (in blue) funds that I estimate exist today.

Diversity Hedge Funds

While estimates of capital inflows vary, eVestment suggests roughly $80 billion in asset flows for 2014, while HFR posits $88 billion. Because the numbers are fairly close, I'm using HFR, but the visual wouldn't be vastly different if I used another vendor's estimate. Here is the HFR estimate of $88 billion in asset flows represented as 1 dot per $1 billion.

2014 Estimated Asset Flows into Hedge Funds

Now, here is the rough amount of those assets (in blue) that went to the Billion Dollar Club hedge funds (also in blue).

Fund Flows Into Large Hedge Funds

And here is the rough proportion of those assets that went to everyone else.

Fund Flows Into Emerging Hedge Funds

Not a pretty picture, eh?

So, what’s the point of my dotty post? While I think we all have read about the bifurcation of the hedge fund industry into assets under management “haves” and “haves nots,” I’m not sure everyone has actually grasped what’s going on. I’m told that a picture is worth a 1,000 words, so maybe this will help it sink in. Not investing in a more diverse group of managers creates a very real risk of stifling innovation and compromising overall industry and individual returns. It also creates a lot of concentration risk - if a Billion Dollar Club fund fails, a large number of investors and a huge amount of assets could be at risk.

And the kick in the pants? We know this pattern isn't the most profitable. A recent study showed pension consultants underperformed all investment options by an average of 1.12% per year from 1999-2011, due largely to focusing on the largest funds and other "soft factors." And lest you think 1.12% sounds small, let me illustrate that for you, too. Here are one million dots, where each dot represents a dollar invested. The blue dots are the cash returns over time that were missed by not taking a more differentiated approach. Ouch. 

Cash Return Differential 1999-2011

Luckily, the cure is simple. Commit to connecting with different and more diverse dots in 2014.

Sources: HFR, eVestment, MJ Alts, Value Walk, "Picking Winners? Investment Consultants' Recommendations of Fund Managers" by Jenkinson, Jones (no relation) and Martinez.

Venn-dication? What Simple Graphs Can & Can't Tell Us About Alternative Investments

Everyone loves a Venn diagram. One of my industry friends insists the single best way to get a ton of views, likes and retweets on LinkedIn or Twitter is to build a pithy Venn. If it’s actually scribbled on cocktail napkin, so much the better.

As a case in point, last week there was an article in The New York Times that showed the “benefits” of hedge funds on one simple Venn diagram.  As my daddy always says, it was PFM - Pure Freaking Magic. 

Source: The New York Times

Of course, me being me, I did have a slight problem with this drawing. Besides the obviously fake napkin motif, it was, in my opinion, a somewhat Venn-dictive Venn.  

For example, when I look at the intersection of the three characteristics diagrammed (expense, appeal to rich people, don’t work well), I see a lot of more likely suspects than hedge funds.

Jaguars, for example. In 2013, Consumer Reports had not one but two pricey Jaguar models on their “Least Reliable” list, leading one magazine to quip that dependability was “in the crapper.” I think that’s a technical term.

And then there’s the laundry list of other things that are expensive, don’t work very well and are loved by rich people. Pre-nups, trophy wives and pool boys all make appearances on this list. Oh, and draping cashmere sweaters over your shoulders. Who the hell came up with that?

But I digress.

The problem, as I see it, is that the characteristics (circles) on a Venn are selected by a person who may have biases. Their agenda then impacts everyone who sees the graph and assumes, like many people do when stuff looks scientific, that its conclusion is fact.

What if, for example, we instead graphed some of the benefits of alternative investments (Yes, contrary to a lot of reporting these days there are some) and determined how they intersected to create strong investment opportunities? How does this change the “story” about whether alternative investments are good for investors? Would that provide any Venn-dication?

@MJ Alts

Hedge funds, for example, as much as some people don’t want to admit it, do have positive traits. Sure, the average fund has underperformed the S&P 500 in recent periods, but between 2007-2009, the average hedge fund kicked the index’s keister (another technical term), providing valuable downside protection and smoothing volatility. More recently, in January 2015, the S&P 500 dropped about 3%, while the average hedge fund was essentially flat, and diversifying strategies like managed futures and global macro gained 3% and 1.7%, respectively. The markets don’t always rocket straight up. You don’t always have time to wait out a correction. You want to sleep at night. Therefore, hedge funds may actually create some value.

Or think about private equity. Sure you could focus on fees and liquidity. Or you could look at the liquidity premium investors potentially score. Over the past 25 years, US private equity has created a 3.4 percentage point differential over the S&P 500. In fact, it is only during the latest bull market that this asset class has been edged by the indices. In part, these returns are achieved due to streamlining balance sheets and the business, which can be a good thing in and of itself. One study showed that sectors with private equity activity grew 20% faster, while another showed that only 6% of PE backed firms end up in bankruptcy or reorganization, a default rate lower than corporate bond issuers. And because private equity invests in, well, private equity, it can be more insulated from market volatility, lowering an investor’s overall correlations.

And let’s not forget about venture capital. Over the past 15, 20 and 25 years US venture capital has more than doubled the returns of the S&P 500. Even in the leaner, dot.com bubble years, venture capital still performed relatively well. And while the average investor now has access to venture investing through crowd funding platforms, they generally can’t bring in significant follow on financing, they don’t get involved in recruiting, they can’t provide office space, search for acquisitions, etc.

So are alternative investments all rainbows and kittens and puppy dog tails? Of course not. My point is simply this: looking only at the pejorative characteristics of anything is counter-productive. It may cause well-suited investors to eschew what might otherwise be an outstanding investment strategy match. Looking only at the positive characteristics may mislead investors into thinking that fees, frauds, losses and other mishaps don’t happen.

Perhaps our dialog and diagrams about alternative investments just need a little balance. Maybe we could even institute a five circle minimum. Regardless of the approach, it's clear we need a more (pun-intended) well-rounded approach.

Sources: The New York Times, eVestment Alliance, Cambridge Associates, The Atlantic “Is Private Equity Bad for the Economy”

What’s In A Name? What Fund Manager Names Tell Us About Diversity

William Shakespeare once asked, “What’s in a name?” believing, as many do, that “a rose by any other name would smell as sweet.” But on this point I must take issue with dear William and say instead that I think names have power. Perhaps this notion springs from being reared on the tale of Rumplestilskin or maybe from teenage readings of The Hobbit. It could be from my more recent forays into Jim Butcher’s Harry Dresden novels.

I know, I know - I never said I wasn’t a nerd.

Regardless of the origins of my belief, my theory was, in a way, proven earlier this week, when the New York Times ran a piece by Justin Wolfers entitled “Fewer Women Run Big Companies Than Men Named John.” In it, the writer created what he called a “Glass Ceiling Index” that looked at the ratio of men named John, Robert, William or James running companies in the S&P 1500 versus the number of women in the same role. His conclusion? For every one woman at the helm of a large company, there are four men named John, Robert, William or James.

To be clear: That’s not just one woman to every four generic men. That’s one woman for every four specifically-named men.

Wolfers’ study was inspired by an Ernst & Young report that looked at the ratio of women board members to men with the same ubiquitous monikers. E&Y found that for every woman (with any name) on a board, there were 1.03 men named John, Robert, William or James.

The New York Times article further showed that there are 2.17 Senate Republicans of the John-Bob-Will-Jim persuasion for every female senate republican, and 1.12 men with those names for every one female economics professor.

While all of that is certainly a sign that the more things change, the more they stay the same, it made me think about the financial world and our own glass ceiling.

In 17 years in finance, I have never once waited in line for the bathroom at a hedge fund or other investment conference. While telling, that’s certainly not a scientific measure of progress towards even moderate gender balance in finance. As a result, I decided it would be interesting to construct a more concrete measure of the fund management glass ceiling. After hours of looking through hedge fund & private equity mogul names like Kenneth, David, James, John, Robert, and William, I started referring to my creation as the “Jim-Bob Ratio,” as a good Southern girl should.

I looked at the 100 largest hedge funds, excluded six banks and large fund conglomerates that are not your typical “cult of personality” hedge fund shops, created a spreadsheet of hedge fund managers/founders/stud ducks and determined that the hedge fund industry has a whopping 11 fund moguls named John, Robert, William and James for every one woman fund manager. There was a 4:1 ratio just for Johns, and 3:1 for guys named Bill.

(c) MJ Alts

And even those ratios were generous: I counted Leda Braga separately from Blue Crest in my total, even though her fund was not discretely listed at the time of the 2014 list.

I also looked at the monikers of the “grand quesos” at the 20 largest private equity firms. There are currently three Williams, two Johns (or Jon) and one James versus zero large firm female private equity senior leadership.

Of course, you may be saying it’s unfair to look at only the largest funds, but I doubt the ratio improves a great deal as we go down the AUM food chain. There are currently only 125 female run hedge funds in a universe of 10,000 funds. That gives an 80:1 male to female fund ratio before we start sifting through names. In private equity and venture capital, we know from reading Forbes that women comprise only 11.8% (including non-investment executives) and 8.5% of partners, respectively. Therefore, it seems extraordinarily unlikely that the alternative investment industry’s Jim-Bob Ratio could fall below 4:1 even within larger samples. Ugh. One more reason for folks to say the S&P outperformed.

Now, before everyone gets their knickers in a twist, I should point out that I am vehemently NOT anti-male fund manager. The gentlemen on those lists have been wildly successful overall, and I in no way wish to or could diminish their performance and business accomplishments. And for those that are also wondering, I am also just as disappointed at the small (read virtually non-existent) racial diversity ratio on those lists as well. 

What I am, however, as regular readers of my blogs know, is a huge proponent for diversity (fund size, gender, race, strategy, fund age, etc.) in investing and a bit of a fan of the underdog. Diversity of strategies, instruments, and liquidity are all keys to building a successful portfolio if you ask me. And, perhaps even more importantly, you need diversity of thinking, or cognitive alpha, which seems like it could be in short supply when we look across the fund management landscape. Similar backgrounds, similar stories, and similar names could lead to similar performance and similar volatility profiles, dontcha think? While correlation can be your friend when the markets are trending up, it is rarely your bestie when the tables turn. And if you don’t have portfolio managers who think differently, are you ever truly diversified or uncorrelated?

In the coming months and years, I’d like to see the alternative investment industry specifically, and the investment industry in general, actively attempt to lower our Jim-Bob Ratio. And luckily, unlike the equity markets, there seems to be only one way for us to go from here. 

Sources include: Institutional Investor Alpha magazine, Business Insider, industry knowledge and a fair amount of tedious internet GTS (er, Google That Stuff) time. 

The Hedge Fund Truth - Launching and Running a Small Fund

The wintry weather of the last several weeks has left me particularly punchy and bored, which of course means I had ample time to create yet another animated video blog for my series "The Hedge Fund Truth." This week it is time for managers (and potential managers) to hear what may be some painful truths about launching and running a small hedge fund. 

In recent years, it seems new funds have been met with a collective "Meh" from the investor marketplace. As we saw in last week's blog, roughly 90% (or more) allocations continue to flow to large, established firms. So what does it take to launch a hedge fund, or any new alternative investment fund, for that matter? Are there non-negotiable keys to success? How should a new manager approach fund raising? Is seeding an option? This 9-minute video attempts to answer some key questions. 

Pattern Recognition May Make You Poorer

As I was trapped in my Nashville home awaiting rescue after Snowpocalypse 2015 from one of Tennessee’s (not kidding) FIVE mid-state snowplows, I watched a lot of television, ate a lot of carbs and tried to fight off scurvy with gin and tonics and a splash of precious lime juice. But at some point, in between re-runs of Shawshank Redemption, Aliens and The Matrix, I was struck by the increasing mainstreaming of behavioral finance.

An advertisement for the Chevrolet Colorado, what is known in the Deep South as a “Big ‘Ol Truck,” highlighted a series of focus groups weighing in on the characteristics of two men, Truck Guy and Sedan Guy. 

Truck Guy and Sedan Guy from Chevy Colorado Commercial

Now, of course Truck Guy and Sedan Guy are, in fact, the same person, but groups of children, adults, single women, bearded men and old folks were asked to describe the characteristics of each man. The result? Truck Guy was rated as 85% more handsome, 76% more resourceful and 100% more likely to have an “awesome pet” than Sedan Guy.

While it may seem like a silly commercial, and obviously one geared towards my fellow Southern brethren, the reactions of the Chevy focus groups were not unlike the biases displayed in other walks of life. Like it or not, pattern recognition and its resultant behavioral biases are active in every decision you make. Unfortunately, in investing, it may be making you poorer.

Pattern recognition, in particular template matching, is the process by which our brains save time. The brain, which consumes more energy than any other organ in the human body, tries to expend the least energy possible to process data and make decisions by taking incoming sensory data and comparing it to what has already been stored in our memory. Hence why a simple picture of Truck Guy elicited judgments about his character and choice of dog when he was otherwise wholly unknown to the focus groups.

It's true pattern recognition can be beneficial – after all, it would be time consuming and exhausting to start over fresh with each new data set all the time a la 50 First Dates – it can also stand in the way of innovative and profitable thinking. In investing, for example, pattern recognition may impact where you direct your capital.

Let’s consider capital flows of assets into hedge funds, venture capital and private equity.

Hedge Funds – In 2014, 86.9% of asset flows went to funds with more than $1 billion under management per HFR. The “Billion Dollar Club” is approximately 500 funds out of an overall universe of roughly 10,000 funds. Per Pensions & Investments, the 25 largest hedge funds control 46% of all hedge fund assets as of the end of the year.

Venture Capital – Per the Wall Street Journal, venture capital firms raised $32.97 billion in 2014, with a mere 8 venture capital firms of $1 billion in AUM or more accounting for just over one-third of that total.

Private Equity – According to industry watcher Preqin – only 7% of the $486 billion raised in 2014 went to first time funds.

Looking at data like this, it’s clear that investors are thinking along the same lines:

·      I should only invest with firms that are BIG.

·      I should only invest with firms that are old (uh, “established”).

·      I should only invest with firms populated by the pale and male.

To many, this seems like a relatively “safe” approach to investing, along the lines of “No one gets fired for buying IBM.” Unfortunately, it doesn’t leave a lot of room for innovation, eye-popping returns, cognitive diversity and true diversification. So by sticking with these established patterns, what are investors potentially leaving on the table?

1)   Research has consistently shown that smaller funds (particularly on the hedged side) often perform better due to the ability to invest in niche plays and club-sized deals. In an increasingly volatile market, smaller funds may be able to be more nimble and liquidate positions in a pinch more easily than larger funds.

2)   Research has also shown that younger firms may post higher returns as well, due in part to the smaller fund sizes above as well as a smaller safety net provided by management fees.

3)   Research has shown that inclusion of women and minorities may increase returns, in some cases substantially. This cognitive and behavioral alpha may not be available, or may be available only in a limited fashion, at the industry’s largest firms. In addition, a lack of diversity at the fund management level may result in less diversification of deals, stocks, ideas and positions, creating additional correlation within a portfolio. In short, investors may not be as diversified as they think they are if all of their managers think alike.

At the end of the day, pattern recognition has created wealth, but it also leaves money (and risk) on the table. It seems to me that we could all be better off, richer and get better gas mileage if we left our prejudices at the door and just rode with Sedan Guy for a while. 

Rampallions & Scullions & Hedge Funds, Oh My!

Last week, MarketWatch ran an OpEd on hedge funds that managed to insult nearly every participant in the financial marketplace. Hedge funds were described as “dethroned kings” ruling over an “empire of fools.” Hedge funds are a “cautionary tale” filled with insider trading, poor performance and investor backlash. Why, it is so bad that investors are no longer “dazzled” and hedge funds may be as bad as (gasp!) mutual funds.

I read that article with its virtually Shakespearean array of insults and actually wondered where the author keeps his money. Some folks have wagered it’s either under the bed or in Bitcoin, although I suppose there’s a slight chance it could be in a sock in the freezer. (Friendly note: that’s one of the first places that a thief will check.)

For those of you that are regular readers of my blog, you know that I’ve dealt with a number of the assertions in this article before. Let’s start with performance. There are few places where the phrase “Your Mileage May Vary” is as applicable as it is in the world of hedge funds. While there is no doubt that the average hedge fund return was anemic in comparison to the (insert sarcasm here) infallible S&P 500, an average provides merely that – the arithmetic mean of the top and bottom performers (and everything in between).

Assuming that all hedge funds generated lackluster returns because the average hedge fund did is just, well, silly. You can look at articles such as this CNBC piece or this ZeroHedge article to see hedge funds that didn’t just outperform their industry average, but kicked the pants off of the S&P 500 as well. There were funds that were up 30 percent, 40 percent, 50 percent 60 percent or more, to which I simply say “Thank you, sir, may I please have another?”  (And for those of you that are wondering, that's from Animal House, not Fifty Shades of Grey.)

For more information on The Truth About Hedge Fund Performance, check out my video blog from last quarter.

I’m also not going to get too deeply into the fee equation as I’ve touched on that a time or two as well. I think the last time was a mere two weeks ago in a blog post about duct tape.

But I have to say, what really buttered my toast this time around was the assertion that, in addition to being greedy underperformers, hedge funds have the corner on the insider trading market as well. The hedge fund inclination to insider trading came up twice in MarketWatch’s short post.

So before we start to tar hedge funds with that particular brush, let’s look at SEC data on enforcement actions, shall we?

The chart below shows all SEC enforcement actions across type and year. Note that insider trading is a relatively small category of enforcement actions. Year over year, insider trading accounts for an average of less than 8 percent of the actions of the SEC, with an average of about 50 insider trading enforcement actions per year.

Source: www.sec.gov

Now, even if ALL of the insider trading was committed by hedge funds, it would still represent a very small proportion of the hedge fund world. Take the ever-present 10,000 fund estimate that the industry favors: If all 50 of those annual insider trading schemes occurred in a hedge fund, then 0.05 percent of hedge funds would in fact be knaves and rapscallions.

But we know that insider trading is not solely committed by hedge funds. How do we know? We can again check out www.sec.gov and get a sense of who does commit this crime. Some of my particular favorites? Accounting firm partners, amateur golfers, vitamin company former board member, drug trial doctors, former BP employee, two husbands, Green Mountain Coffee employee, and the list goes on. And it’s true that some of these folks made millions in ill-gotten gains, although one guy got only $35,000 and a jet-ski dock. That dude must LOVE to jet ski.

Look, I’m not saying that some hedge fund managers haven’t done bad things. There certainly are hedge funds represented on the insider-trading list, and just today there was an article on a manager that faked his death to avoid paying back investors. But shenanigans aren’t limited to hedge funds and finance. For example, cell phone companies generate about 38,420 complaints per year, in comparison.

At the end of the day, I just wonder how good it is for the finance industry or for investors to totally defame the entire investment industry and slam hedge funds in particular. I am a fan of exploring all my investment options. Attempting to remove those options through “fund shaming” is ultimately bad for me and other investors. To the extent this kind of misinformation impacts inflows, encourages closures and causes qualified investors to dismiss hedge funds out of hand, it can only result in fewer investment options, lower returns and higher correlations and volatility. 

What “How I Met Your Mother” Can Teach Us About Hiring Fund Raising Staff

As regular readers of my blog know, once a month I try to offer some unsolicited advice to fund managers out on the capital raising trail. Today, I want to tackle the touchy topic of how to hire a great fund marketer.

Fans of “How I Met Your Mother” are likely familiar with the Vicki Mendoza line and its impact on Barney’s decision making. Leaving aside Barney’s oh-so-politically-incorrect humor on dating for a moment, it is possible to apply his matrix-based decision-making to other areas of life, like, for example, choosing a fund marketer.

The Contacts/Context Graph for Fund Marketing Success.

Hiring a marketer (or negotiating salary/bonus?) Where do you fit? (c) MJ Alternative Investment Research

On the Y-Axis I have created a Contacts scale. This measures the relative strength of the contacts your potential marketer is bringing to the table. Please note that the scale starts at 2 because, frankly, for the right price, anyone can obtain a list of investor targets from any number of sources. If that’s news to you, try Googling “Investor List” and you’ll be shocked by what you can buy.   

Of course, there are contacts and then there are contacts. With lists easily available (and potentially overused and/or out of date), it is important to judge the quality of the contacts, not just the quantity, as well.

• I started with a basic list as a 2.
• A good list with some personal (not just purchased or Googled) contacts gets a 4 to 6.
• Because it’s important not just to know investors, but to know the investors who match well with the fund’s strategy and life cycle, a robust list with at least some relevant personal contacts (e.g. the right type of investors for your fund, be they individual investor, family office or institutional) gets a 6 to an 8. After all, an emerging manager who hires a public plan marketing specialist may have difficultly quickly securing the early capital they need.
• Finally, an outstanding list with deep, relevant, personal contacts who have a history of investing with the marketer gets an 8 to a 10. 

The X-Axis is the Context Scale - how this individual fits in the context of my firm. Unfortunately, I had to start this scale with a -2 since there are some hires that are not only not a great fit with your organization, they are actively bad for your firm.

For example, I still remember the marketer I met more than 10 years ago who, after unsuccessfully pitching me in 5 minutes at an Opal conference cocktail hour said, and I quote, “Well, I’m here to raise assets, not to make friends. I’ll catch you later.” Or the guy who called me and my staff at Van Hedge on Fridays to ask if we were ready to invest yet. Every. Freaking. Friday. As a result of his calls, spontaneous laryngitis was common and highly contagious in our office at the end of each week.

Rest assured, folks like those will not only be unsuccessful at raising assets for your firm, they will also actively diminish your brand and reputation in the industry.

Think of it this way: I still remember the exact words from these guys after more than a decade. And while I am occasionally accused of being a little Rain Man-esque when it comes to facts, I can assure you that a bad impression lasts a really long time, no matter who you are.

The Context scale attempts to measure a number of things: sales skill, their personality fit in the overall make-up of the firm, willingness to pitch in outside of their domain, knowledge of the strategy and industry, attention to detail, compliance focus, proactive versus reactive nature, organizational skills, etc. It’s a broad scale, and I would suggest that before you start looking for a marketer you think about what elements of Context are most important to you and your firm.

So, let’s get down to brass tacks.

• If a potential hire scores below 0 on the Context line, they are firmly in the NO GO ZONE. No matter what their Contacts score look like.
• Below a 5 on both scales is what I call the Danger Zone. This may be a decent hire, but you should watch for friction within the organization and/or longer-lead time sales. A large part of their success will depend on attitude, general people skills and EQ.
• Above a 5 on the Contacts line but below a 5 on the Context line and you should consider hiring the individual as an outside contractor or a third party marketer (3PM). This will minimize friction in the organization (and any blowback outside the firm) and allow you to still capitalize on the marketer’s contacts.
• A 5 to 10 on the Context scale but low scores on Contacts means the person could be an excellent fit for the organization, but perhaps not the best marketer. They could be a tremendous addition to another area of the firm (investor relations, operations, entry level marketing) but will need time to build relationships and “season.” Understand that if you make a marketing hire in this zone, patience will likely be required.
• The Safe Zone contains good hires. They may be slower to fit in or to close business, but chances are they will get there.
• Between an 8 and a 10 on the context scale and a 6 to 8 on the contacts scale you’ll find Really Good Marketing Hires.
• If someone scores between an 8 and 10 on both scales, you should give them equity and encourage them to work at your firm forever. Actual golden handcuffs may be required.

Even, if you aren’t looking to make an internal hire, the Contacts/Context matrix works for third party marketers as well. We all know that 3PMs don’t always have the best “street cred” in our industry, but there are good choices out there. Select candidates using the Contacts/Context criteria and then rank further based on things like retainer, length of contract, trailing commission, geographic focus, etc.

Of course, there are exceptions to every rule, matrix and formula, but at least thinking through the issues raised by the Contacts/Context Matrix before making an internal or external hire should help you position your fund well above the Midas Line. 

Don't Get Your Duct Tape In A Wad

On a recent flight from New York to Nashville, I took my seat on Barbie’s Dream Plane, otherwise known as a commuter jet, and was faced with a vehicle in such disrepair it actually unnerved someone who has flown more than 1.5 million miles in 15 years. And yes, that would be me.

I looked across the aisle and found a similarly “fixed” window one row back, and suddenly my thoughts were filled with being sucked out of a plane somewhere over West Virginia. The flight was virtually empty (leading my pessimistic mind to conclude that everyone else was smarter or luckier than I not to be on the explosive decompression-mobile) so I asked the flight attendant about the rather homey “repair.”

“It’s amazing!” she said. “And our CEO makes $57,000 per day and still uses duct tape.”

Well, I guess $57,000 will buy a helluva lot of duct tape - 16,913 rolls at WalMart by my calculations.

After I had safely landed in Nashville, however, I started wondering: Why do folks get so worked up over what hedge fund, private equity and other fund managers get paid, and don’t get nearly as vitriolic over a $57,000 per day gig at a corporation? I asked some friends and did some soul searching, and here’s what I came up with:

1.    Financial services professionals don’t do “real work.” Over the course of several days, I asked friends and family why it was ok for an airline CEO to make $20 million plus per year, but complete, foaming at the mouth, anathema for a hedge fund or private equity fund manager to make bank. Their (almost universal) response? Managing money isn’t “real work.”

The first time this response was given I chuckled a little. But after the next five to six responses I began to bristle and wonder, do people even understand what money management entails?

Running an investment firm requires the same skills and efforts of running a small business. You must manage, hire and fire employees. Appropriate policies, procedures and compliance must be established and followed. Relationships with service providers must be initiated and maintained. Client communication is required. Marketing is not optional. Of course, you have to create and maintain a successful investment track record. And if you think that is easy, chew on this: Only 1 in 100 day traders are “predictably profitable.”

Managing an investment firm is really no different than running an airline, albeit on a much, much smaller scale. And of course, investment firms find the use of duct tape is generally verboten when dealing with institutions and high net worth individuals.

2.    We think the “Rich List” is reality. Every year, Forbes and other publications publish their “Richest Hedge Fund Manager” lists, striking envy and loathing into the hearts of readers around the globe. And while it’s easy to be gobsmacked by the fact that Ray Dalio is worth $15.2 billion, John Paulson $13.7 billion and Paul Tudor Jones $4.3 billion, this is not the reality for most fund managers.

I’ve done the math for you before, but suffice it to say that the base pay for the AVERAGE hedge fund manager is something closer to $500,000-$750,000. While this is certainly a lot of money, it’s not as far in the stratosphere as one might think. Medscape reports that an orthopedic doctor can bank $413,000 or more annually as well. One study showed the median CEO pay package at companies with $1b in revenue was $15.1 million in 2012. And the top 0.1% of earners in the U.S.? Roughly 40% of them are top management at corporations, excluding finance.

If you want to know what pay is really like in the hedge fund universe (or if you're negotiating your bonus), look at SumZero’s report on hedge fund compensation. And remember, only 0.07% of hedge fund managers are billionaires.

3.    We focus more on fees than value. Roughly two weeks ago ago, I tweeted that CALPERS would be reducing the number of private equity managers in their portfolio to reduce fees. Almost immediately after the tweet, um, tweeted, I received a reply asserting that maybe CALPERS just didn’t get enough out of their private equity investment to justify costs.

How much has CALPERS made off private equity per their own website? $31 billion over 14 years.  Likewise, hedge funds have returned $1.5 trillion after fees over the last decade according to AIMA.

At the end of the day, investors invest to generate returns. We all know this doesn’t happen in a vacuum, without skill or without a significant investment of time and energy and business acumen on the part of those managing money. Frankly, my biggest concern when looking at my investment portfolio is my net return. If I am happy with that, I don’t necessarily dwell on what someone else is making. After all, I don’t likely have the skill, staff, time or expertise to generate a similar return.

It’s truly unfortunate that we’ve become almost singularly focused on investment manager income rather on diversification and value creation, but that’s where we seem to be. As a case in point, a February 1, 2015 article on the dearth of female fund managers pointed to one possible reason for the lack of estrogen on Wall Street: “On average, women appear to place more importance on feeling that their job has a clear value to society,” said Anne Richards of Aberdeen.

And I guess that leads me to wonder, when did making folks money, safeguarding retirement and financial goals, or helping pensions fund liabilities lose its value?

Don’t Listen to Greg Weinstein

In the 2000 movie release “Boiler Room” Greg Weinstein (in)famously talked about how to sell stocks to women. His advice? Don’t.

“We don't sell stock to women. I don't care who it is, we don't do it. Nancy Sinatra calls, you tell her you're sorry.” – Greg Weinstein

While I’m not on a Hollywood big screen, I am here to tell you this: Greg Weinstein is a moron.

Let me give you a few facts about women, wealth and investing.

• Studies have shown that women control 51.3% of personal wealth, and that number is expected to grow to 66% by 2030;
• U.S. women are an economy equal in size to the entire economy of Japan;
•  Women make up 47% of the top wealth holders in the U.S.;
• Women are either the sole decision maker or an equal decision maker in up to 90% of high net worth households;
• A 2014 MainStay Investments study showed that 89% of women who had invested in alternatives had a positive experience and that 27% of women (compared with 20% of men) are looking towards alternative investments; and,
•  High net worth women are more likely to invest in alternative investments. According to a 2015 CNBC article women are “three times more likely to invest in hedge funds, venture capital and private equity and twice as likely to invest in commodities and precious metals.”

Affluent women are a powerful and growing force in the alternative investment investor landscape.

According to a 2014 Preqin report, high net worth investors account for 9% of hedge fund investors by type and 3.6% of the total assets in hedge funds. For many emerging hedge funds, high net worth investors comprise up to 100% of their assets under management. High net worth investors are therefore a critical part of the alternative investment investor-verse.

One final fact: Preqin released statistics on Monday showing that assets under management in alternative investments (including hedge funds, private equity, real estate, private debt and infrastructure) has grown to $6.9 trillion dollars.

If high net worth investors account for 3.6% of the AUM in alternatives, then nearly $250 billion of all alternative investment assets come from their pockets.

If women are sole or equal decision makers in 90% of high net worth households, then women control or influence nearly $225 billion of alternative investments.

As managers struggle to raise assets, as RIAs and CFPs look for new clients, as first funds look to launch, there should be a concerted effort to integrate this significant segment of the investor-verse. Failure to do so is not just short sighted, it’s also business-limiting.  

If you haven’t started thinking about how you can attract female investors, it’s time to start. I attended a women and wealth conference in New York last week. There were only three men in attendance. One was a speaker. One worked for another speaker. I didn’t get a chance to meet number 3, but suffice it to say that, based on my experience last week, it seems the emerging market that is women is continues to be overlooked by the financial services industry.

Wake up, y’all. Greg Weinstein was wrong.

Sources: Fara Warner: “Power of the Purse” & the American College of Financial Services, IRS, Bank of America Merrill Lynch, CNBC, Preqin)

#SaveTheEmergingManager

Recent asset flow patterns and fund closures reveal that small (and new) hedge funds may be on the endangered species list. Recent data shows that funds need at least $250 million to break even, and even that may not be enough to successfully run a business. But if small hedge funds go the way of the dinosaur, what happens to structural alpha? Will niche investments, club deals and micro-caps be permanently overlooked? Where will investors look for outsized returns and differentiated portfolios?

Recent asset flow patterns and fund closures reveal that small (and new) hedge funds may be on the endangered species list. Recent data shows that funds need at least $250 million to break even, and even that may not be enough to successfully run a business. But if small hedge funds go the way of the dinosaur, what happens to structural alpha? Will niche investments, club deals and micro-caps be permanently overlooked? Where will investors look for outsized returns and differentiated portfolios?

New Year’s Resolutions for Investors and Managers (Part Deux)

Last week I directed everyone’s post-holiday attention to making New Year’s Resolutions for investors. Now that everyone has had a week to digest those mantras, get over the soreness you inevitably felt after hitting the gym (for the first time in 12 months) diligently, and have balanced your ketones after a week of low-carb, New Year dieting, I thought it best to turn attention to resolutions for money managers.  If you missed last week’s post, you can find it HERE. For those of you still looking to make a few investing resolutions for 2015, read on.

Money Manager Resolutions:

I resolve to create a business plan around capital raising – Raising and maintaining assets under management has perhaps become as critical as performance. Don’t believe me? Look at recent fund closures. Paul Tudor Jones just announced the shuttering of his longest standing fund, which at $300 million was absorbing a disproportionate amount of firm resources. Merchants Gate, which peaked at $2.3 billion in AUM, decided to close as assets shrank to $1.1 billion, despite above average performance. Woodbine Capital closed after assets dipped to $400 million. Indeed, during the first half of 2014, Hedge Fund Research (HFR) reported that 461 funds closed, which was on pace to equal or exceed the worst year on record for hedge fund liquidations: 2009.

While many people believe that hedge funds “fail” in a blaze of glory a la Amaranth or Galleon, most hedge funds die a death of 1,000 cuts, either never gaining enough performance traction or amassing enough assets to create a sustainable business. According to a 2012 Citi Prime Services report, hedge funds now need between $250 million and $375 million just to break even, and the relatively large closures listed above make me believe the number may be closer to the higher end of that spectrum.

So, with ten hedge fund firms accounting for 57 percent of asset flows in 2014, what’s a fund to do? At the very least, make a plan. If I’ve said it before, I’ll say it again: Your capital raising efforts should be executed like Sherman marching through Georgia in 2015.

We all talk about the “business and operational risk” in hedge funds, and I, for one, would include an effective capital raising (and retention) strategy as one of those risks. Without an effective asset raising campaign, a hedge fund manager may have to:

1)   Spend more time on capital raising, potentially taking time away from generating strong performance;

2)   Worry more about redemptions. Any redemption payouts will likely have to be liquidated from the active portfolio, potentially compromising returns;

3)   Lower the investment minimum so investors will invest (and not be too large of a percentage of the fund). Sure, more investors is great, but client communications will also take more time;

4)   Constantly assuage investor (their own and their employees) fears about the long-term sustainability of the fund.

In 2015, make a plan for capital raising. Pick three to four conferences with a high concentration of potential investors and really work them. Get on the speaking faculty. Get the attendee list in advance and set up meetings before you arrive. Have great materials available. Practice your elevator pitch. After the event, have a plan for follow up. Write great investor letters. Polish your performance template. Host a webinar on your strategy. Hire a writer/capital raiser/graphic designer or whatever you need to fill in the gaps. People are already predicting 2015 will be a worse year for hedge fund closures – Let’s prove folks wrong. 

(NOTE: This does not mean I don't think there is still a place for small, niche funds. If a manager is content and profitable and generating returns smaller, that's fantastic, and needed in the industry). 

I resolve to find my own niche, but not tell everyone I’m the only one there – If I read the words “Our competitive advantage is our fundamental, bottoms-up [sic] stock picking” one more time, I will put out my own eye with a pencil. It’s very hard for a traditional stock picker to demonstrate alpha right now, so you must find, demonstrate and articulate an edge.

The fact is, many of the investors to whom I speak have vanilla investing covered. Whether it’s equities, private equity or credit, if it ain’t something they can’t do themselves, they aren’t likely to invest. If you do something really unique or spectacularly well, make sure you highlight that in every conversation and in all of your marketing efforts. For example, I’ve seen managers with great equity strategies market themselves as simple long/short funds, when in fact there is much more meat in their burger. Don't hide your light under an anemically worded bushel.

With that being said, I think if I hear “I am the only one who is long ________ now” one more time, I will poke out my eardrums with a number two pencil. Hubris is never attractive, and it can result in some spectacular losses. Just ask Long Term Capital Management.

At the end of the day, you often need other folks to figure out the equation (although preferably after you do) in order for your ideas to generate returns. If no one else ever unearths your undiscovered company, or piles into energy, or gets on your disruptive bandwagon, you’ll end up holding a nice position at par for a really long time. Not as attractive, eh? Explain why you're early in, but also why others will eventually get the memo for the best results.

I resolve to stick to my guns – This one may be tough. With the amount of pressure on money managers to outperform, avoid all losses, lower fees and generally walk on water, it can be hard to stay with a strategy that hasn’t been shooting the lights out, hold the line on fees to protect a fund’s long-term viability or not branch into strategies where expertise may be lacking. It’s also a fine line between maintaining conviction and riding an idea or stock to the bottom. For the most part, trust what you know. Explain when you have to. But always at least listen to what others and your intuition are telling you. 

Wishing all of us a safe, happy and prosperous year!