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

Hedge Fund Truth Series: Hedge Fund Fees

Thinking about a hedge fund investment? Concerned about high fees? Before you request a fee reduction, consider that there isn't a "one size fits all" approach to fee structures. Fee reductions for smaller funds may introduce significant business risks and create counterproductive incentives. Fee reductions for larger funds may be desirable and more sustainable, but are also likely to be in shorter supply and may create negative selection bias. In short, investors AND managers should weigh the costs and benefits of slashing fees before they get themselves into an investing pickle. 

Thinking about a hedge fund investment? Concerned about high fees? Before you request a fee reduction, consider that there isn't a "one size fits all" approach to fee structures. Fee reductions for smaller funds may introduce significant business risks and create counterproductive incentives. Fee reductions for larger funds may be desirable and more sustainable, but are also likely to be in shorter supply. In short, investors AND managers should weigh the costs and benefits of slashing fees before they get themselves into an investing pickle. For more blogs visit www.aboutmjones.com

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 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

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

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

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.

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. 

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 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!

New Year’s Resolutions for Investors & Managers (Part One)

As we enter 2015 refreshed from vacations, overstuffed with tasty victuals and perhaps even slightly hung-over, it’s time for that oh-so-hopeful tradition of New Year’s resolutions. Many of you probably resolved to spend more time with your family, eat better, exercise more, floss daily, or to give more to charity. Despite what the research says, some of those resolutions may even stick. So before the holiday afterglow completely fades, I would like to turn attention to some investing resolutions, designed to bring more (mental) health, wealth and happiness in 2015. Without further ado, here are my top three New Year’s resolutions for investors. (Due to the length of this post, I’ll cover money manager New Year’s resolutions in next week’s blog.)

Investor Resolutions for 2015

I resolve to not confuse absolute and relative returns – When you profess to want “absolute returns” you do not get to invoke the S&P 500 in the same breath. In 2014,  “absolute return” came to mean “I expect my investments to absolutely beat the S&P 500” or “My investments absolutely cannot lose money (or I will redeem them at my first opportunity).”  

Absolute returns actually means you make an investment in an asset class or strategy and then you judge whether you are happy with those returns based on absolute standards. Did the strategy perform as expected, based on returns, volatility, drawdown, and/or diversification? Do I still believe in this strategy or asset class going forward? If there was a loss, do I believe this is a substantial, long-term problem or is this a buying opportunity? Trying to turn absolute investments into relative investments after the allocation fact causes a lot of knee-jerk investment decisions, leads to return chasing and, ultimately, underperformance.

I resolve to not get tied up in my investing underpants – This probably needs some explanation because I do not want any of my blog readers to Google “tied up in underpants”  - the answers you get will absolutely not be suitable for work.

Instead this (quaint?) colloquial saying basically means that you shouldn’t get so wrapped up in perfecting the small things (underpants) that you can’t get to the big stuff (getting dressed and leaving the house).  For example: “That meeting was worthless. We spent all morning tied up in our underpants about where to get lunch and we didn’t address the sales quotas.” For non-Tennesseans, the less colorful turn of phrase would involve forests, trees and all that.

When it comes to investing, there are any number of “underpants issues” with which to deal. Fees are a great example. Every time someone wants to argue with me on Twitter about alternative investments, they inevitably start with “You don’t have to pay 2%/20% to [get diversification, manage volatility, achieve those returns, etc.]."

It’s always interesting to chat with these folks about what they think an appropriate fee structure would be. Most people say they are willing to “pay for performance.” And in fact, perhaps with the exception of investments into a small number (less than 500) of “billion dollar club” funds, you are.

Since more than half of all funds have less than $100 million in AUM, it’s pretty difficult for the bulk of funds to get rich from a management fee alone. Management fees tend to be, on average, around 1.6%. In comparison, mutual funds charge between 0.2% (index funds) and 2% in management fees, with the average equity mutual fund charging, according to an October 6, 2012 New York Times article, around 1.44%. Not that different, eh? As for the incentive fee, that only gets paid if the manager makes money. It’s designed to align interests (“I make more if you make more”), not steal from the “poor” and give to the rich. Perhaps a hurdle makes sense, but why dis-incent a manager entirely?

At the end of the day, this laser focus on fees hampers good investment decision-making. We run the risk of focusing too much on what we don’t want others to have than on what we might get in return (diversification, a truly unique or niche strategy, reduced volatility, expertise, returns). We run the risk of negative selection bias (with managers and with strategies) if we choose only low fee funds. We also risk dis-incentivizing smaller, niche-y and more labor-intensive start-up funds, which could completely homogenize the investment universe.

Is there room for fee negotiation? Of course. I am a big proponent of sliding scales based on allocation size or overall AUM. However, making fees your sole decision point is, I believe, penny wise and pound foolish over time and will leave you, well, tied up in your underpants.

I resolve to take a holistic approach to my portfolio – Say this with me three times “I will not chase returns in 2015. I will not chase returns in 2015. I will not chase returns in 2015.”

Why should auld performance be forgot? Let’s look at managed futures/commodity trading advisors. It hasn’t been an easy ride for macro/futures funds. In 2012, they were the worst performing strategy according to HFR. In 2013, they were edged out of last place in HFRs report by the Barclays Aggregate Bond Index, but still under performed all other hedged strategies. The last two years saw heavy redemptions, with eVestment reporting outflows from Managed Futures funds for 26 of the last 27 months.

And in 2014? Managed Futures killed it.

Early estimates from Newedge show that Managed Futures funds returned an average of 15.2% in 2014. January 2015 predictions are that Managed Futures will either win or place amongst top strategies for 2014.

It’s always tempting to dress for yesterday’s weather, but savvy investors look not just at what’s performed well, but where there are future opportunities and potential pitfalls. Even an up-trending market, maybe especially in an up-trending market, it’s important to look to out-of-favor and diversifying strategies, niche players and contrarians to create a truly “all weather” portfolio.

Stay tuned for money manager resolutions next week, and in the meantime, best wishes for a Happy Investing New Year.