Crisis Communication for Investment Managers

Crisis communications isn't something most money managers practice very often. Well, I guess if they did, they probably wouldn't continue to manage money very long. But last week's market volatility was a great crisis communication "pop quiz" for investment managers. In case you failed the test, or if you just want to boost your score with investors, here are some tips for effectively communicating with investors and prospects during a crisis, whether it's market-driven or created by personnel, regulatory bodies, service providers, or litigation. Communicating effectively during a crisis can make or break a business, so study up and ace the next test.

(C) MJ Alternative Investment Research

The Love of the (Returns) Chase

Managed Futures/Macro funds reported investor outflows throughout 2014, ending the year down $35.06 billion and $19.13 billion, respectively. So, clearly the performance of these funds must have been sucked big time, right?

Yeah, um, not so fast.

On January 8, HFR reported that Macro/CTA funds had posted their 8th gain in 9 months, ending the year beating all other hedge fund strategies. In fact, they were one of the top performing strategies in the first quarter of the 2015, too.

And just like that, the chase was on. eVestment reported that Managed Futures and Macro hedge funds gained $14.18 billion and $4.01 billion in AUM, respectively, during the first half of 2015.

Ah! We fickle investors! Pretty soon we’ll probably just have a Tinder app for hedge funds and skip due diligence and asset allocation all together. The app will display only past performance and allocate straight into the limited partnership from your bank account. I smell a unicorn.

Swipe right if you agree.

(c) MJ Alternative Investment Research

It seems to be human nature to chase performance. Whether it’s due to overconfidence, miscalibration, Dunning-Kruger, familiarity, the disposition effect or simple greed and fear, we appear to be hard wired to make decisions based on past performance. Even if we know that PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS - or, as I like to put it, you ain’t gonna get what they got, you’re gonna get what you get. Unfortunately, the SEC isn’t keen on my translation, yet.

Now, don’t get me wrong. I loves loves loves a CTA/Macro fund. I wrote a paper when I was at Barclays showcasing the reasons why diversifying strategies such as these deserve permanent placement in a portfolio (and 2014 plus the last three days kinda proved my point), so it’s not that I’m anti-quant, systematic, macro, trend followers or anything else. And frankly, given the way the market has behaved over the last several days, this may be one of the few times when return chasing may actually work for investors.

Regardless of my personal biases and whether we’re about to enter the next great Stockapalypse, I do think it’s a good time to remind everyone that performance chasing is generally not a great strategy for great returns.

First off, all investors, no matter how large a pool of capital they command, are resource constrained to some extent. The amount of staff they have available for investment due diligence, operational due diligence and ongoing monitoring tends to be fairly finite. When you chase returns, you generally have to transfer resources from what one would assume is a rational investment plan to what amounts to a fire drill. At the end of the day, this can make your long-term investments suffer in favor of short-term (potential) gains.

And perhaps more importantly, return chasing simply doesn’t work. Studies of both retail and institutional investors show that fired fund managers often go on to outperform their replacements. In one Vanguard study, the average outperformance of a buy and hold investor versus performance chasers was 2.8 percentage points. In another (S&P/Dow Jones) study of U.S. equity mutual funds, past performance was not a predictor of future results 96.22% of the time.

In the alternative investment space, if you look at HFR’s Winner’s and Losers chart (you know, that colorful quilt like chart they produce annually) from year to year, it is rare to find a strategy in favor for more than 24 months at a time. Last year, it was CTA/Macro, the prior two years it was the S&P 500. 2011 saw Barclays Gov’t Credit in the lead. In 2010 the S&P 500 emerged victorious again. 2009 saw relative value – convertible win the race. 2008 was another win for Barclays. In 2007, it was emerging markets funds. In fact, Macro/Futures funds were in the bottom two strategies in 2012 and 2013 before topping everything else in 2014.

Let’s face it, past performance is not your friend, it’s your frenemy.

There are a lot of ways to make investment decisions that don't rely solely, or even primarily, on past performance of a particular fund or strategy. The outlook for the strategy, the qualifications of the manager, your own risk-reward mandate and parameters as well as a holistic portfolio plan can all be great guideposts during the investment selection process. 

Hell, you might even take a (gasp!) contrarian approach. 

I was speaking with an investor on Monday morning when the Dow was down about 1,000 points at open. While lamenting the loss, they also stated “well, at least it’s a good buying opportunity.” Those words made me want to do a little dance, make a little love, and get down on a Monday night (uh uh, uh uh). After all, our mantra is still buy low, sell high, not the other way around.

Oh, and PS - So proud I made it through that entire blog without an "I told you so" moment. Oops. Damn. 

Sources: HFR, S&P Dow Jones, Vanguard, eVestment

People Call Me A Skeptic (But I Don’t Believe Them)

I’m a data nerd. I know it. You know it. It’s not like it’s a big secret. My name is Meredith Jones, and I let my geek flag fly.

So it’s no wonder that my nerdy spidey senses tingled late last week and early this week with the release of two new hedge fund studies. The first was eVestment Alliance’s look at small and young funds - version 2.0 of the emerging manager study I first launched at PerTrac in 2006. The second study, authored by hedge fund academic heavy weights Andrew Lo, Peter Lee and Mila Getmansky, looks at the impact of various database biases on aggregate hedge fund performance.

Neither paint a particularly bright picture of the overall hedge fund landscape.

So why aren’t I, Certified Data Nerd and long-time research of hedge funds, rolling around on the floor in piles of printed copies of each study right now? Because, in addition to being a total geek when it comes to a good pile of data, I’m also a big ol’ skeptic, and never moreso than when it comes to hedge fund data.

Here’s the thing, y’all. Hedge fund data is dirty. Actually, maybe even make that filthy. It's "make my momma  want to slap me" dirty. Which is why it is critical to understand exactly what it is you may be looking at before jumping to any portfolio-altering conclusions. Some considerations:

One of the reasons I imagine Lo et al undertook their latest study was to show just how dirty hedge fund data is. They looked at backfill bias and survivor bias primarily, within the Lipper Tass database specifically. Their conclusion? When you adjust for both biases, the annualized mean return of hedge funds goes from 12.6% to 6.3%.

Ouch.

However, let’s consider the following:

No hedge fund database contains the entirety of the hedge fund universe. A 2010, comprehensive study of the hedge fund universe (again, that I completed for PerTrac) showed that 18,450 funds reported performance in 2009. Generally speaking, hedge fund databases cover roughly 7,500 or fewer “live” hedge funds. So, no matter what database you use, there is sample bias from the get go.

And while backfill bias and survivor bias do exist, so does participation bias.

Because a fund’s main motivation to participate in a hedge fund database is marketing, if a fund does particularly poorly (survivor bias) or particularly well (participation bias) it may stop reporting or it may never report. For example, of the top ten funds identified by Barron’s in 2014, three don’t report to Lipper Tass, two are listed as dead, two more aren’t reporting current data and three do report and are current. This could be sample bias or it could be participation bias. Hell, I suppose it could be survivor bias in some way. In any case, it does show that performance gleaned from hedge fund databases could be artificially low, not just artificially high.

As for emerging manager studies – they run into a totally different bias – one I’ll call barbell bias.

Unfortunately, due to wildly unbalanced asset flows over the last five years towards large funds, 85% of all hedge funds now manage less than $250 million. More than 50% of funds manage less than $100 million. Indeed, the hedge fund industry looks a little bit like this:

Some of you may remember my “Fun With Dots” blog from a few months ago. Using that same concept (each dot represents a hedge fund, each block has 100 dots and each line 1,000 dots, for a total of 10,000 dots, or funds) the Emerging vs. Emerged universe looks like this: 

(c) MJ Alts

What’s interesting about this is, at least mathematically speaking, every fund in the large and mid sized category could have been outperformed by a smaller fund counterpart, but because of the muting effect that comes from having such a large bucket of small funds, the small fund category could still underperform.

Now, of course, I still found both studies to be wildly interesting and I recommend reading both. Again: Nerd. I also know that people have poked at my studies over the years as well, which, frankly, they should. Part of the joy of being a research nerd is having to defend your methodology. In addition, most people do the best they can with the data they’ve got, but it’s not for nothing that Mark Twain stated there are “Lies, damn lies and statistics."

What I am saying is this: Take all studies with a grain of salt. Yes, even mine. 

In hedge funds - perhaps more than anywhere else, your mileage may vary. You may have small funds that kicked the pants off of every large fund out there. Your large funds may have outperformed your emerging portfolio. You may have gotten closer to 12% than 6% across your hedge fund universe (or vice versa). Part of the performance divergence may come from the fact that it’s hard to even know what the MPG estimates should be in the first place, which is why it’s critical to come up with your own return targets and expectations and measure funds against those indicators and not industry “standards.” 

Sources: Barron's, CNBC, Bloomberg, LipperTass, MJ Alts, PerTrac, eVestment Alliance

(Humorous) Perspective on the Due Diligence Process

After spending some quality time with managers and investors recently, I've come to realize that, while they have a lot of respect for one another, they also have a lot of frustration with one another's due diligence processes. Here's their thoughts about each other's due diligence in a (somewhat sarcastic) nutshell. 

Tongue in cheek? Perhaps. But I think there's more than a little truth in those cartoons. 

Maybe we should try to agree to exercise a little more peace, love and understanding about what drives the due diligence process from both sides of the fence. For managers, efficiently (if not perfectly) responding to every investor and due diligence request is paramount, since asset flows for most managers are tight. For investors, who are also resource constrained, eliminating managers quickly that won't 'make the cut' is key, while fiduciary responsibility and headline risk contributes to a high stakes process. I think both sides agree the process is far from perfect, but perhaps there are ways to tweak the process, rather than see the other side as an adversary.

The Wrong Barn Door?

Every Thursday there is a crisis at my house. A big one. It involves Hollywood movie scale running, hiding and yelling. The best FX team has nothing on the Matrix-like special effects that go on Chez MJ. And I can always tell the crisis is starting when I see this:

Yes, my Thursday Crisis is the Invasion of the House Cleaners. It’s scary stuff because, you know, vacuums and rags and spray bottles (oh my!).

How my cats learned to anticipate the Thursday Crisis is beyond me. I suppose there are subtle clues. I get up a little earlier to pick up and unload the dishwasher. (No judgment! I bet if I did a scientific poll about people who clean before their maids arrive the results would show I’m in the majority). I make a least one trip to the laundry room to grab clean sheets and towels. Whatever it may be, Spike and Tyrone have learned to watch for Thursdays with the diligence of Jack Nicolson guarding us against Cuban communism in A Few Good Men (“You can’t handle the vacuum!”).

For the rest of us, watching for the next financial crisis is a bit more nuanced. Last week, for example, I read two articles that made me wonder if we even understand what a crisis is, or if we all believe financial panic is as predictable as my housecleaners’ arrival.

The first article looked at the state of venture capital in the U.S. New figures, released by PriceWaterhouseCoopers and the National Venture Capital Association showed that venture capital investments in companies reached $17.5 during the second quarter of 2015, their highest totals since 2000. However, the article argued that, given that the total projected investment for 2015 (more than $49 billion) was less than the total amount invested in 2000 ($144 billion) and that the number of deals is lower as well, it couldn’t be another tech wreck-venture capital bubble in the making.

The second article looked at the risk precision of Form PF – a document introduced post-2008 to better understand and measure the risks created by hedge funds. The article cited two instances where hedge funds had proven their ability to destabilize economies: George Soros’ attack on the GBP in 1992 and Long Term Capital Management, the first "too big to fail", in 1998. Given that the hedge fund industry is now much larger than it was during those two “crisis”, it of course stands to reason that the risks created by hedge funds are now exponentially greater as well.

Or are they? 

Both articles were extremely interesting and presented compelling facts and figures, but they also were intriguing in that both seemed to assume that, at least in part, we experience the same crisis repeatedly. That perhaps we have a financial boogeyman waiting outside of the New York Stock Exchange every Thursday, much like my housecleaners.

But the reality is, a crisis is often a crisis precisely because we don’t see it coming. Each meltdown looks different, however subtly, from the one that went before. Which begs two questions:

1. Are we always slamming the barn door after the horses are gone?
2. And going forward, are we even worried about the right barn door?

Let’s look at a few financial meltdowns as examples.

1987 – Largely blamed on program trading by large institutions attempting to hedge portfolio risk.

1990s – Real estate crisis caused by market oversupply.

1998 – Asian markets (1997) plus Russia plus Long Term Capital Management– a hedge fund leveraged out the ying yang (technical term).

2000-2002 – The tech wreck. Could be blamed on “irrational exuberance”, changes to tax code that favored stocks with no dividends, or excessive investment in companies with no earnings (or products in some cases).

2008 – Credit meltdown created largely by overleveraged consumers and financial institutions.  Real estate crisis created by demand (not supply).

2011 – Sovereign credit issues, not a total meltdown obviously, but noticeable, particularly in many credit markets.

While these are gross oversimplifications of each period, it does show a clear pattern that, well, there ain’t much of a clear pattern. Bubbles happen largely due to macro-economic investor psychology. Everyone jumps on the same bandwagon, and then decides to jump off at roughly the same point. Think of it as Groupthink on a fiscal level. It isn’t easy to break away from Groupthink and it’s often even harder to spot, given that we’re often part of the group when the bubble is building.

So what’s the point of this little rant? Do I think we’re at a new venture capital bubble? I don’t know. The market has changed dramatically since 2000 – crowdfunding, Unicorn Watch 2015, lower costs for startups, and shows like “Shark Tank” are all evidence of that, in my opinion. And are hedge funds creating systemic risk in the financial markets? I don’t know the answer to that question either, but ETFs have now eclipsed hedge funds in size and robo investors are gaining ground faster than you can say “Terminator,” and LTCM was nearly 20 years ago, so it seems unlikely that hedge funds are the sole weak spot in the markets.

I guess I said all that to say simply this: If we spend too much time trying to guard ourselves against the problems we’ve already experienced, we’re unlikely to even notice the new danger we may be facing. If my cats only worry about Thursdays, what happens if the plumber shows up on Tuesday? Panic. If you drive forward while looking behind you, what generally happens? Crash.

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Sources: http://www.entrepreneur.com/article/248784, http://www.ibtimes.com/hedge-fund-risks-may-be-bigger-regulators-know-despite-dodd-frank-2033322

The Evolution of a Female Fund Manager

It's time for another jaunty infographic blog this week! This time we're looking at the sometimes rocky road from childhood to female fund manager. The excellent news? Parents, educators and employers can all help remove hurdles by being aware of these obstacles and taking small steps to level the playing field, and understanding and encouraging behavioral diversity in investment management. 

(C) MJ Alternative Investment Research

Trust Me, I’m a Portfolio Manager!

Last week’s post on the softer side of investing garnered a question from an intrepid reader:

Just how does a manager go about building trust and a personal relationship with investors and prospects?

Excellent question, and since I regularly offer unsolicited advice on how to further capital raising efforts, one on which I am more than happy to opine. So with very little ado, here are MJ’s Top Ten Ways To Build Better Relationships With Investors and Prospects. While this list isn’t quite as funny as the Top 10 Bad Names for Businesses (http://www.ultimatetop10s.com/top-10-bad-names-businesses/), it may just save you from closing your fund to become the next franchisee for this business. 

http://www.ultimatetop10s.com/top-10-bad-names-businesses/

Top Ten Ways To Build Better Relationships With Investors and Prospects

1. Have conversations, not monologues. When you walk in to give an initial pitch or a portfolio update do you spend the majority of the time giving your spiel? Do you doggedly march through your pitch book? How much time passes before you ask your audience a question? Before you launch into your pitching soliloquy, ask your audience some questions about themselves, their portfolio and their investment goals. Pause on your table of contents and ask, “Here’s what I would like to cover today, what would you like to spend the most/least time on? Are there other topics you’d like to address?” Take notes, plan your time accordingly, and instead of taking your audience on a PowerPoint Trail of Tears, tailor the time you have for maximum & (most importantly) mutual productivity.
2. Always tell the truth, even if the answer is “I don’t know.” This goes for you and your entire staff. I can’t tell you the number of times I’ve gotten one answer from a marketing/cap intro source and a different answer from a portfolio manager. Always remember: “I’ll get back to you on that.” is a perfectly acceptable reply.
3. Put information about your staff and other support personnel in your pitch book and DDQ. We all remember the phrase “Two guys and a Bloomberg” from the good/bad old days of investing. Well, my friends, those day are gone (if they ever existed). No portfolio manager is an island and, whatever your stud duck fantasies may be, it takes more than one person to manage money. Not including the firm’s staff in a pitch book (including outsourced services) creates two problems for investors. A) They have to ask how tasks get done, which an investor shouldn’t have to wonder and B) it may make them think that the manager does not value their staff. Employee turnover, particularly in CFO, CCO, COO, key analyst and other functions, can be almost as devastating to a fund as manager turnover, so I worry both about hubris and employee satisfaction when I don’t see a pretty little org chart. With names.
4. Talk about your background, but then, um, stop talking. I have met with managers who spent an entire meeting taking me on what seemed like a minute-by-minute tour of their professional bio. And don’t get me wrong: I care. I just don’t care that much. I can read your bio. I need to know what you see as the key inflection points and the highlights of why your background qualifies you to run the fund. I do not need an hour-long history lesson that starts off a la Steve Martin in The Jerk.
5. Call before bad news arrives… A fund of funds manager friend of mine has one cardinal rule: Call me before you end up in the Wall Street Journal. I would add to that: Call me before a large, out of character loss. Call me when your entire market segment is blowing up. Call me if one of your peers is having public valuation issues and tell me why you’re not and won’t. Give your investors and prospects a heads up and they will come to trust you more.
6.  …but don’t only call for bad news. If you only call when things are bad, investors develop a Pavlovian response to your phone calls. Call with good news once in a while (e.g. a really good month, a terrific new hire, a great new investor, you’re going to be on CNBC…).
7. Talk about what you’ve learned and how you learned it. One of the things many investors want to know about a money manager is what they’ve learned and that they are capable of continued learning. If a particular drawdown or market scare made you change your strategy or thinking about certain scenarios, that’s great to talk about. A long time ago, a prior firm had an investment with a manager that experienced significant losses during a market meltdown. When we sat with him to discuss the portfolio, he talked about that period and said that if he had it to do over again, he would sell off the book and start over. When the markets went into the pooper (technical term) in 2000, the manager did just that. He was able to avert large losses, he showed that he could learn, and he gained additional trust because he did what he said he would do, all in one fell swoop.
8.  Let people know what scares the pants off of you from a market or investment perspective. In 1999, I met with a famous money management firm to evaluate one of their funds for investment. I asked them about their worst market scenario and how they would react. They said that they couldn’t imagine a scenario where they wouldn’t see what was coming and get out of the way well in advance. Less than six months later they lost over 20% in one month. So much for that legendary foresight, eh? Every manager will lose money. Being honest about when and how a fund can lose money and how you plan to react lets your investors sleep better at night.
9. Don’t hide behind jargon, buzzwords, or opaque language. At a “speed dating” capital introduction event many years ago, a frantic event organizer begged me to go into the room with a fund manager who was, um, lonely. It seems investors came to his sessions but quickly received urgent calls or emails and had to depart. I attended his session and quickly learned why. The manager didn’t want people to figure out his “secret sauce” so he talked in the most pompous, jargon-filled manner imaginable. I wanted to shank myself with my coffee stirrer within 15 minutes. Hiding behind big words, complex math and opaque terms doesn’t make a manager sound smarter. It makes them sound scarier and riskier. It means investors have to ask questions that make them feel stupid. Word to the wise: When you make people feel dumb, they seldom give you money.
10. Know your client.  This goes beyond the B/D definition and fun compliance videos we've all had to watch and hits on a personal level. To the extent possible, make an effort to know key facts about every client. Where do they live? Are they married? Do they have kids? What do they like to do when they aren’t asking you every question on the AIMA DDQ? Being able to have an actual personal discussion moves your relationship out of simple transactions. Don’t underestimate the power of the personal connection. 

Investing in Portfolios, Performance & People

I realized I was getting a bit long in the investment industry tooth the other day when I actually started a sentence with “Back in my day…” In fact, all I needed was a cane and the ability to shoo kids out of my front yard for a full flashback to the crotchety down-the-street neighbor from my youth.

What aroused this fit of curmudgeonly angst, you may ask? Well, sad to say it was a pitch book.

Many of you know that I spend an inordinate amount of time looking at pitch books. I’ve seen long ones and short ones. Blue, black and green ones. Stapled, bound, slick, fancy or plain, I’ve seen so many pitch books my retinas have paper cuts.

Recently, while looking through a stack of pitch books I noticed a disturbing trend.

Title Page

*flip*

Tiny Print Disclaimers No One Reads

*flip*

Table of Contents

*flip*

Fund Highlights

*flip*

Performance

*flip*

Investment Process

*flip*

Portfolio Construction…

*flip*

Wait. Something is missing. *flip* *flip* *flip*

Hmmmm…*flip* *flip* *flip* *flip*

Oh wait….HERE it is…Firm and Manager Information. At the end? You betcha. Sometimes it was even in the appendix.

Look, don’t get me wrong - I recognize that investors are laser focused on returns. With all the underfunding and under-saving and underperforming, I get it. Returns matter. But they aren’t (or shouldn’t be) the only factor in the investment decision-making process.

Back in my day…

When I started investing in the late 1990s, we had a slightly different modus operandi for choosing hedge funds. Sure, we screened for alternative investment options based on returns (where available), but we didn’t get a lot of elaborate pitch books. Often all we got was a PPM, a conversation and, if we were lucky, some sort of beverage during our meeting. There wasn’t necessarily a formal “pitch” and the meetings generally entailed a lot of Q&A. My write-ups for the rest of the investment committee weren’t limited to number of positions, leverage, and service providers (although those were certainly important), but also included my general impressions of the manager and staff.

After all, we were placing money in a fund, but we were actually entrusting it to a person. And while it’s nice to think about percent returns, alpha, beta and the whole carful of Greeks, the decision of whether we were interested in a fund couldn’t be isolated from how we felt about the people to whom wrote that big freakin’ check.  (Ok, it was a wire, I’m not THAT old).

Unfortunately, I think relationships and trust can get lost in DDQs, tear sheets, check boxes and stress tests, and the proof is in the pitch book pudding. Managers are eschewing bios, org charts, firm details and even grim, blank wall mug shots for pages and pages of data.

And even though my first question has always been “can this person manage money?” it has always been followed by “and can I trust them to do so?”

I mean, you can't just divorce the process & performance from the person. Even in the most quantitative strategies, with the most robust black box systems or rigorous analysis ,a person is at the helm, programming risk levels, making assumptions about the markets and investments & deciding who to trust with that information. In short, people matter & you should know & understand those people as well as you understand the strategy. 

Think of it this way, if you trust your fund managers you sleep better at night. Combined with robust operational controls, you don’t worry that the manager may be running off to Key West to follow Jimmy Buffet with your money and a Coral Reefer tee-shirt. You also communicate better. Chances are the fund manager will engage with you more, and in a more open fashion. Simply put, the relationship and trust you mutually establish makes it easier to keep your mind on your money and your money on your fund managers’ mind. And of course, volatility is easier to stomach. In times of market or strategy volatility, you’re less likely to second guess or panic. If you trust the manager is executing the strategy you hired them to do, and you believe the market opportunity continues to exist, you can handle a loss.

If you think the manager is a lunatic, an a-hole, a loose cannon or in any way resembles Leonardo Dicaprio from Wolf of Wall Street in any way, none of that is possible.

Now, don’t get me wrong – I am not anti-research. Anyone who knows me (or even knows of me) understands that I let my Geek Flag fly. I also am familiar with the growing body of research that shows we have a tendency to make bad decisions when we rely only on our intuition. I’m also not anti-pitch book – I think a great pitch book helps before, during and after a meeting. But I do think we could all use a little reminder that, at the end of the day, we’re investing in people, and those people can ultimately make or break our investment experience.

So managers, put on a clean tie and go stand in front of your conference room wall, get your school picture taken and put it, and information about you and your staff, in your pitch book BEFORE you go too far down the strategy rabbit hole. And investors, look up from the checklist from time to time and think about whether you like, trust and can talk to your fund manager – you’ll both be glad you did.

Swingers And The Art of Investor Communication

For those of you that were fans of the movie Swingers you may remember this infamous scene:

“[It's 2:32am, and Mike decides to call Nikki, a girl he met just a few hours ago][Nikki's machine picks up: Hi, this is Nikki. Leave a message]

MIKE: Hi, uh, Nikki, this is Mike. I met you at the, um, at the Dresden tonight. I just called to say that I had a great time... and you should call me tomorrow, or in two days, whatever. Anyway, my number is 213-555-4679 -

[the machine beeps. Mike calls back, the machine picks up]

MIKE Hi, Nikki, this is Mike again. I just called cuz it sounded like your machine might've cut me off when I, before I finished leaving my number. Anyway, uh, and, y'know, and also, sorry to call so late, but you were still at the Dresden when I left so I knew I'd get your machine. Anyhow, uh, my number's 21 -

[the machine beeps. Mike calls back; the machine picks up again]

MIKE: 213-555-4679. That's it. I just wanna leave my number. I didn't want you to think I was weird or desperate, or... we should just hang out and see where it goes cuz it's nice and, y'know, no expectations. Ok? Thanks a lot. Bye bye.

[a few more calls. Mike walks away from the phone... then walks back and calls again; once again, the machine picks up]

NIKKI: [picks up] Mike?

MIKE: [very cheerful] Nikki? Great! Did you just walk in or were you listening all along?

NIKKI: Don't ever call me again.

[hangs up]”

Yeah, communicating with potential investors can feel a bit like that.

Lionsgate Entertainment

In fact, a few years ago I was speaking with an investor friend in Switzerland about manager communication. I asked him how much he liked to hear from his current managers and potential investments and, as was his wont, he laconically answered “Enough.”  When I pressed him a bit further, he provided a story to illustrate his point.

“There is a manager that I hear from every day it seems. Every time I open the mail or get an email or answer the phone, I know it must be them. Finally, I started marking ‘Deceased’ on everything they sent and sending it back. Eventually the communication stopped.”

Seriously, when you have to fake your own death to escape an aggressive fund marketer, they’ve probably gone just a HAIR too far, donchathink?

All kidding aside, communication (how much and how often) is a serious question, and one that I get a lot from fund managers, particularly those frustrated with a lack of progress from potential investors.

While some managers react to slow moving capital-raising cycles by reducing or ceasing all communication (bad idea!), others move too far in the other direction, potentially killing (hopefully just figuratively) their prospects with emails, letters, calls, etc.  But there is a happy medium for investor communication if you follow these simple guidelines.

Early communication – In the earliest days, just after you’ve met a new potential investor, your goals for communication are simple:

1.  Provide key information about the fund (pitch book, performance history);
   
2. Attempt to schedule a meeting (or a follow up meeting) to discuss the fund in person;
   
3. Establish what additional materials the prospect would like to see (DDQ, ongoing monthly/quarterly letters, audits, white papers, etc.)
   
4. Send those materials

Your only goal at this stage is to see if you can move the ball forward to get to a meeting or a follow up meeting. Think of it like dating. Just not like Swingers dating. You always want to try to move the ball down the field, with the realization that being overzealous is more likely to get you slobberknockered than a touchdown.

Ongoing communication – After you have established a dialog with a potential investor, you should have realized (read: ASKED) what that investor wishes to receive on an ongoing basis. You should continue sending that. In perpetuity. Unless they ask you to stop, or they literally or figuratively die. Think about how much communication that an investor receives from the 10,000 hedge funds, 2,209 private equity funds, and 200+ venture capital funds that are actively fundraising. If your fund falls completely off the radar, how likely is it than an investor will think about you down the line? Yeah, them ain’t good odds. Your ongoing communication should consist of a combination of the following:

1. Monthly performance and commentary;
   
2. White papers (educationally focused);
   
3. Invitations to webinars or investor days that you are hosting or notifications about where you will be speaking;
   
4. Email if you are going to be in the prospects’ vicinity to see if an additional meeting makes sense.
   

In addition, it is a good idea to establish an appropriate time to call during your meetings. For example, after the initial or follow up meeting, ask specifically when you should follow up via phone. And then do it – no ifs, ands or buts. Even if performance isn’t great at the moment. Even if you feel you’ve now got bigger fish to fry. Make the call. And during that call, make an appointment for another call. And so on and so on and so on.

The trick here is to keep the fund in front of a potential investor without being in their face. And to do that, you MUST ask questions and you must be prepared to hear that another call and/or meeting may not make sense at the moment. Take cues from potential investors. Trust me, they’ll appreciate you for it.

During Due Diligence – If you are lucky enough to make it to the due diligence stage, I would suggest preparing a basic package of materials that you can send to expedite the process and demonstrate a high level of professionalism.

1. AIMA approved DDQ – And don’t leave out questions. We’ve all seen these enough to know when questions have been deleted. If a question isn’t applicable put in N/A.
   
2. References
   
3. Audits (all years since inception)
   
4. Biographies of principals
   
5. Organization chart
   
6. Offering documents
   
7. Articles of incorporation
   
8. Investment management agreement
   
9. Information about outside board members
   
10. Service provider contacts
    
11. Valuation policies (if applicable)
    
12. Form ADV (I and II)
    

After The Investment – After an investor makes an investment in your fund you should stay focused on your communication strategies. Ideally, you should agree with the investor BEFORE THE WIRE ARRIVES what they wish to see (and what you can provide) on an ongoing basis. This will help avoid problems in the future. You can earn bonus points by including any ODD personnel on materials related to operational due diligence, since they don’t always get shared between IDD and ODD departments.

Also, make sure you pick up the phone when performance is particularly good OR particularly bad. Many managers will call when performance is bad for advance “damage control,” but only calling when performance is bad creates a negative Pavlovian response to caller ID.  Don’t be the fund people dread hearing from.

Hopefully these guidelines will help as you navigate the fundraising cycle. And if not, hey, Swingers quote.

Sources: IMDB.com, CNBC, NVCA

The Confidence - Hubris Conundrum

The dictionary defines hubris simply as “excessive pride or self-confidence.” Personally, I prefer to use the traditional Greek-tragedy definition, which is “excessive pride toward or defiance of the gods, leading to a downfall caused by an inescapable agent.” It’s likely we’ve all experienced hubris in our own lives on at least a small scale. My own “inescapable agents” have at least once arrived in the form of roller skates and tequila. That was pre-Instagram, thankfully.

In the investment management industry, however, hubris is an entirely different animal. And whether the inescapable agent comes in the form of a regulator or the markets, I can tell you that in my 17 years of fund research, I have found few things that will blow up a fund manager faster than a heapin’ helpin’ of hubris. Long Term Capital Management. Beacon Hill. Galleon. Manhattan. Maricopa. Madoff. The list of investment professionals that have bitten the big one thanks to hubris is the stuff that splashy headlines are made of.

Of course, some degree of self-confidence is necessary to become and remain a successful investor. If a fund manager doesn’t have some strength of conviction in an investment, a strategy, a team or him- or herself, compelling, long-term outperformance will be nigh on impossible.

Like many things, however, confidence is a continuum, and when I look at fund managers, I like to see folks who are ideally in the middle of the spectrum. I’ll often take one degree on either side of balanced as well.

But the end of the spectrum? Well, let’s just say them dogs will bite you.

But how do you determine where a current or potential fund manager sits on the Hubrometer? Here are some key questions I’ve asked (and phrases I’ve heard) over the years that may be helpful cues.

1. What are your worst investment nightmare scenarios? Yes, it seems like a somewhat simplistic question, but you would be shocked at the number of managers that either A) can’t come up with a response or B) say they think they have covered all of their bases and don’t have one. As much as I’d like to believe a manager who tells me they’ve hedged everything perfectly and constructed an indestructible portfolio, I’ve got to call horse hockey on that one, friends. Bad things happen to good fund managers. The best managers are always trying to figure out what those bad things may be and position accordingly. Superb managers aren’t afraid to share that information with you because they are confident enough to know that some degree of uncertainty isn’t a sin. And knowing what you'll do when the "fit hits the shan" can be the difference between a containable loss and a catastrophic one.
2. “I think the market is wrong on that one.”  - This phrase is usually uttered when someone has maintained a long-term losing position (or worse, someone who is being creative with their marks). In these scenarios, the market is always wrong - it is never the manager. But let’s remember, in investing, you have to be right and you have to be right at the right time. As Bull Durham said, “Sometimes you win, sometimes you lose and sometimes it rains.” Into every portfolio some rain will fall, and knowing the difference between a spring shower, a drawn out monsoon, and a Noah-esque flood is critical.
3. Any gilding of the lily is a bad, bad sign. This can take the form of inflating assets to appear more credible (you can check assets with a quick call to a custodian & believe it or not, I’ve caught more than one manager with this one) or even providing information on degrees that weren’t actually obtained (no, attending graduate school but not getting the MBA aren’t the same things). The key is to match words with reality here. If a manager says the fund has never been leveraged more than 2:1, look at the audit. If it shows 2.3:1, you need to talk. If a manager gives information about risk controls but then breaks them “just this once,” you’ve got an issue. Little things mean a lot.  And someone who thinks they can get away with a little white lie that can be easily checked is often willing to fib about the bigger things, too.
4. “I’m the only fund manager using this strategy.” While I suppose this could be true, Wall Street is full of pretty smart people. It’s rare that someone finds an edge that another person hasn’t already thought of, or didn’t think of soon after. If you find yourself alone in a strategy, I think a confident person should wonder if it’s possible they are early, illegal or wrong. When I hear this statement I like to ask which camp the manager believes the fund belongs in and why. Then I go see who else is using the strategy. Sometimes this is an honest mistake on the manager's part, and sometimes it's actually fear that if you find other funds that are using the strategy, you may want to invest with them instead (doubt disguised as hubris). Still, always worth checking. 
5. The redeemed investor reference. Redeemed investors are the honey badgers of the investing world. They generally don’t care what gets back to a fund manager and will be brutally honest about when K1s arrived, how easy it was to get in touch with the manager and staff with questions, and what kinds of returns they actually received. Always talk to redeemed investors. Ask them all of the above as well this: “What’s the worst thing you can say about Fund Manager?” Sometimes you get ridiculous answers (I once had a guy describe the insanely fat fingers of a fund manager, concluding the call with “his hands don’t even look human.” Other times I’ve gotten tidbits that were a bit more useful). Look for inconsistencies here, too. 

Of course, these are just a few suggestions to help separate the confident wheat from the hubris chaff. Have other suggestions you’d like to share with your fellow investors? Put them in the comments below. 

The Most Hated Profession on Earth

Yes, it's time for yet another blog in the Hedge Fund Truth Series. Lately, it seems that an incredible amount of ire has been directed at hedge funds, fueled by four primary beliefs about the industry. While I've blogged about each separately, I thought it would be a good idea to address all four statements in a simple, 6 minute blog to separate fact from fiction. Is hedge fund performance terrible? Do hedge fund managers work? Why are you paying more taxes than your friendly neighborhood hedge fund manager? And what's with the billion dollar salaries anyway? Oh, and I threw in a couple of hedge fund "Mean Tweets" for good measure. 

Obviously, there's more to each of these topics than I could possibly fit into 6 minutes. If you want to pursue any topic further, please visit my blog archive for multiple, longer discourse on the topics. 

This is another blog in the Hedge Fund Truth Series. Lately, it seems that an incredible amount of ire has been directed at hedge funds, fueled by four primary beliefs about the industry. While I've blogged about each separately, I thought it would be a good idea to address all four statements in a simple, 6 minute blog to separate fact from fiction? Is hedge fund performance terrible? Do hedge fund managers work? Why are you paying more taxes than your friendly neighborhood hedge fund manager? And what's with the billion dollar salaries anyway? For more on the Hedge Fund Truth, please visit www.aboutmjones.com.

Sources: AIMA, Washington Post, Forbes, Investopedia, Barron's

Hedge Funding Kindergarten Teachers

There's been a lot of debate over the last week, and really over the last several years, about hedge fund pay. Some discuss hedgie compensation in absolute terms while others prefer comparative stats. Without a doubt, the comparison of top hedge fund manager compensation to that kindergarten teachers has become one of the more incendiary debates, but is it really a relevant or useful comparison? Are hedgies the only group that eclipse K-teachers in pay? We already know the answer is "no", but let's take a moment to look at the facts in this week's infographic blog. 

(c) 2015 MJ Alternative Investment Research

The Crystal Ball in the Rearview Mirror

Last week, a headline in the International Business Times grabbed my attention. It was entitled “Utah Public Pension Fund Audit Calls for Reconsidering Hedge Fund Investments.” In case the headline wasn’t unambiguous enough for you, it was basically yet another article talking about how hedge funds have underperformed and, well, “off with their heads!” 

A recent independent audit of Utah’s $32 billion plan evidently revealed the following:

1. Utah’s alternative investment portfolio has increased from 13% of fund assets in 2004 to 40% of fund assets in 2014.
2. If Utah had maintained its (stock heavy) asset mix at 2004 levels, it would have gained an additional $1.35 billion over the past 10 years.
3. Employees must now pay more out of pocket due to pension shortfalls. (Along with 90% of other state pension constitutents who did or did not invest similarly).

That’s it, Utah. We’re canceling Christmas.

Seriously, as we look back over the past 10 years, it is perhaps easy to be smug about the money one could have made. After all, it’s easy to predict the future now that you’ve already lived it. It may also be impossible to not think of the massive coulda shoulda woulda money left on the table by not going all in long the S&P 500 on March 9, 2009. After all, in the five years after the 2008 market debacle the S&P 500 has generated an eye-popping 17.94% annual return.

But after the latest bull market run, it’s important to remember that one can only make decisions based on the information available at the time. We don’t have a crystal ball, and the one in the rearview mirror doesn’t count. While one can generally state that the markets will make gains over time (the S&P 500 does generate 10-year gains over five percent 84% of the time, after all), it’s nearly impossible for anyone to say when those gains may come or how much one stands to profit.

Just for grins and giggles, let’s take a moment and enter the MJ WayBack Machine to travel back to 2004. I’ll even hum Outkast’s “Hey Ya!” to get you in the appropriate mood.

• In 2000, the S&P 500 had dropped -9.1%.
• In 2001, the S&P 500 had dropped another -11.89%.
• In 2002, the S&P 500 had dropped yet another -22.10%.

That’s not a pretty picture. In fact, based only on our recent experience, it is probably pretty easy to forget that two of the S&P 500’s only four losing 10-year periods just ended in 2008 and 2009. That’s right, fellow MJ Waybackers, it ain’t been that long ago since we saw a decade end in losses. And that’s exactly what Utah was living through in 2004.

In light of that particular scenario, does it seem THAT unusual that Utah’s investment pension staff might have thought a shift away from equities into hedged vehicles could have been, in fact, a good idea?

And that gamble initially paid off. According to the audit, the pension’s hedge fund positions offered protection against 2008’s market losses. Had the 2004 stock-heavy allocation still been in place at that time, the Utah’s pension would have lost an additional $436 million.

In fact, I’m betting the 2009 memo read quite a bit differently than the most recent audit, but I doubt many would take the other side of that trade.

However, in the wake of 2008’s losses, we’ve seen the S&P 500 generate almost historic gains. In fact, only 3 five-year periods eclipse the recent post-crisis 5-year annual returns: the five years following 1981 when the S&P 500 gained 19.87% (annualized); the period following 1953’s loss, the S&P 500 generated 5-year annualized gains of 22.30%; and after the Great Depression’s 1931 loss of -43.34%, the S&P 500 went on to gain 22.47% over the next five years.

So, yes, we’ve seen this "incredible gains after losses" movie three times before. But we’ve been to the theatre expecting to see this movie a whopping 24 times. And yes, the market gains have been almost unbeatable lately, but they also aren’t necessarily the norm.

And also consider this. The S&P 500 is an asset-weighted index. Apple (APL) makes up 4% of the index, and it was up roughly 63% over the last 12 months.  That one stock is one of the only things that prevented a 1Q2015 S&P 500 loss. Eight of its other top 10 holdings were in the red. My point? This bull market could turn on a dime.

But I digress.

What I think we’re seeing with Utah (and a host of other investors, individual and institutional) is a classic case of budding FOMO. And the Fear of Missing Out is not generally a good investment strategy.

At the end of the day, did Utah (and any other investor who finds themselves in a similar position) make reasonable decisions based on the information they had at the time? Sure. Are others who jumped all in to the market rally now having a more rewarding experience than they are? You bet. Could the resultant FOMO potentially set investors up to become less sensitive to risk in their haste to “keep up”? Yup. Could that strategy eventually bite them in the ass? Uh yeah. And I’ll bet that will make for an interesting memo, too.

Sources: NovelInvestor.com, International Business Times, AdviceIQ.com

The Declaration of Fin-Dependence

Given that one of the hedge fund industry's largest events takes place this week (SALT), that the Sohn 2015 event featured an emerging manager session and that it's just capital raising season in general, I thought it might be appropriate to share a little unsolicited fund marketing advice in this week's blog. 

All too often, I hear about breakdowns in fund marketer/fund management relations. Fund management becomes disenchanted with how the asset raising process is going (read: slowly). Fund marketing feels pressured to raise assets for a fund that isn't performing well (read: poorly). Fund management feels that they (their three year old child, their neighbor's teenager or the guy on the street corner) could do a better job of bringing in capital. Fund marketing feels unappreciated (duped or downright angry) when bonus time rolls around. 

It doesn't have to be this way. 

To help avoid these common problems, I've put together a Declaration of Fin-Dependence. It's always important to remember that capital raising is not a solo sport and, even though I've seen it come to this, it ain't a contact sport either. In order to achieve capital raising success ($1 BEELION dollars, world domination, Rich List, etc.), it is critical that management and marketers both set and manage expectations carefully and execute on their common goals. The less ambiguity, the better. So, take a moment to read this historic document and then think about adding your John Hancock before you go after the Benjamins. 

The Declaration of Fin-Dependence

Diversification and Alpha - By The Book

A recent article in The Washington Post posited that Americans are currently under-saved by $14 trillion or more for retirement. According to a 2014 Bloomberg report, all but six state pension plans are under-funded by 10% or more, 40 by 20% or more and 31 by 25% or more. Although many investors seem to have forgotten 2008, it was a mere seven years ago that the markets experienced their worst dip since the 1930s, with the S&P 500 losing 38.5% and the Dow dropping 33.8%. Despite a seven-year bull market, we should all do well to remember that poop can, does and will happen. It’s merely a question of when.

In my opinion, that’s why it pays to invest in the “broad market.”

Gender and investing is a sensitive subject. I have a lot of conversations with industry participants about why diversity is good for the financial industry and end investors, and why diverse managers, particularly women, exhibit strong outperformance. I think I’ve created some converts. I think others believe that I’m completely insane. However, I do believe that in order to overcome the tremendous financial hurdles that we face, we must think creatively about how to increase diversification, minimize bubbles and boost returns.

At the end of the day, many financial professionals are trained to think about diversification in a number of straightforward dimensions.

• By Strategy – long-only versus hedged, diversifying strategies (managed futures/macro/market-neutral equity), etc.
• By Instrument – equities, bonds, commodities, real estate, etc.
• By Liquidity – liquid listed instruments versus OTC versus private investments, etc.
• By Number of Investments – the more investments, the less any one can hurt a portfolio

But what we really don’t spend much time thinking about is diversification of behavior. Behavior is an inescapable reality of investing. What happens to your investments is undeniably impacted by behavior – yours, your broker, your money manager and macro-economic behavior - they all play a role in generating gains and losses.

As a result, I believe it’s key to not only have a diversified portfolio of investments with different and diversifying strategies and instruments, it’s also important to have investment managers that will behave differently when approaching the markets. And that’s where women come in.

A number of research studies show that women approach investing differently than men in terms of:

1. Biology – Even though women are often stereotyped as “more emotional” when it comes to investing, that may not be the case. Brain structure and hormones impact how men and women interact with the markets, and can influence everything from probability weighting to risk taking to market bubbles.
2. Overconfidence – There have been a number of studies that show men have a higher tendency to be overconfident investors. Overconfidence can manifest in a myriad of poor investment practices, including overconcentration in a single stock, not taking money off the table, riding a stock too far down (“It will come back to me”) and overtrading.
3. Better trading hygiene – One very crucial side effect of overconfidence is overtrading. Overconfident investors tend to act (buy or sell) on more of their ideas, which can lead to overtrading. Over time, overtrading can significantly erode investment performance.
4. Differentiated approach to risk – Although women are often stereotyped as being more “risk adverse,” the truth of the matter is a bit more nuanced. Men and women weigh probabilities differently, with women generally having a flatter probability weighting scale. This means they tend to not to inflate expected gains as much as their male counterparts, which can be beneficial in risk management and in minimizing overall market bubbles.
5. Avoiding the herd – Women may be more likely to look at underfollowed companies, sectors, geographies or deal flow in order to obtain an investment edge.
6. Maintaining conviction – Female investors may be better at differentiating market noise from bad investments. Women tend to be less likely to sell underperforming investments simply because of broad market declines.

There have been a number of studies that showcase that these differentiated behaviors can really pay off. From studies by HFR, Eurekahedge, Vanguard, my work at Rothstein Kass (now KPMG), NYSSA, the University of California and other academic institutions, research suggests that women’s cognitive and behavioral investment traits are profitable.

Alpha and additional diversification - how can that possibly be a bad thing?

Now, before I become a complete pariah of the financial world, I’m not saying that investors should eschew male-managed funds for sole devotion to women-run funds. That would merely switch the behavioral risk from one pole to another. What I am suggesting is that if we are focused on minimizing risk and maximizing return, we should at least consider the idea that cognitive and behavioral alpha do exist and pursue them through allocations to women (and minority) fund managers.

Of course, anyone who has spoken with me over the last, oh, two years, knows by now that I’ve been faithfully working on a book that addresses these very issues. Today, after furious scribbling, interviewing, transcription, and maybe just a little swearing and throwing of my cell phone, Women of The Street: Why Female Money Managers Generate Higher Returns (and How You Can Too) was released by Palgrave Macmillan.

Available on Amazon.com and other book retailers.

To be honest, I kind of want to barf when I think about people reading my behavioral manifesto. But mostly I just hope that it makes us think about what we all stand to gain by looking not just for the next Warren, Julian, John or David, but also for the next Marjorie, Leah, Theresia and Olga.

Sources: CNN Money, The Washington Post, Bloomberg, Women of The Street: Why Female Money Managers Generate Higher Returns (and How You Can Too).