Are You The Next Blackstone? Don’t Count On It.

During an unbelievable number of meetings with investors and managers, I hear the same two refrains:

“We’re looking for the next Blackstone.”

Or

“We think we’re the next Blackstone.”

It’s enough to make you wonder if such success is commonplace or if we’re all overreaching just a teeny bit.

Well, I’ve shaken my Magic Eight Ball and the answer is this, at least for newer funds: “Outlook Not So Good.”

Recently, on a boring Sunday afternoon, I decided to go through Institutional Investor’s list of the 100 largest hedge funds and figure out when each fund company launched.

Yes, clearly I need more hobbies.

But the results (as well as my lack of social life) were pretty shocking. There are no funds within the top 100 that launched during the last 5 years. There are only 4 funds in the top 100 that launched within the last 10 years. In fact, nearly 70% of the top 100 hedge fund firms launched before the first iPod.

Obviously, this begs a question: Where are all the new Blackstones?

(c) 2015 MJ Alts

Whatever complaints can be lobbed at hedge funds, I do find it hard to believe that the talent pool has deteriorated to such a degree that there just isn’t a supply of skilled fund managers available. On the other hand, I do have a few theories on what forces may be at work.

1. Change In Investor Dynamics: For a long time, hedge funds were the investment hunting ground of high net worth individuals and family offices. In fact, pre-1998 saw little to no meaningful investment of institutional capital into hedge funds, and investment activity into hedge funds didn’t accelerate markedly until after the Tech Wreck. But by 2011, 61% of all capital in hedge funds was institutional capital. But why should this matter? Imagine you’re an institutional investor with $1 billion or more to invest into hedge funds. Imagine you have a board. Imagine you have headline risk. Imagine you are hit on by every fund marketer known to man if you go to a conference. Imagine you have policies that dictate the percent of assets under management that your allocation can represent. Now, try to put that capital to work in a reasonable number of high-performing hedge funds. It seems reasonable to assume that the investing constraints of being a large institutional investor would drive allocations towards larger funds with longer track records. Just like you never get fired for buying IBM, it’s unlikely you’ll be canned for investing with Blackstone, AQR, Credit Suisse or other big name fund complexes.
2. Market Timing: According to HFR, assets in hedge funds grew from $490.6billion in 2000 to nearly $1.9 trillion in 2007, or more than 287%. One of the reasons for this surge in assets is, I believe, prevailing market conditions. Having just exited one of the greatest bull markets in history and entered two of only four 10-year losing streaks in the history of the S&P 500, hedge funds had an opportunity to well, hedge, and as a result, outperform the markets. Unlike the last 6-ish years (recent months notwithstanding), where hedge funds have been heavily criticized for “underperforming” during an almost unchecked market run-up, market conditions were more favorable to hedged strategies between 2000 and 2008. This allowed managers with already established track records and AUM to capitalize on market and investor demographic trends and secure their dominant status going forward.
3. Evolving Fund Management Landscape: Let’s face it – the financial world was a kinder and gentler place before 2008. Ok, that’s total BS, but it was less regulated. Hedge funds were not required to register with the SEC, file Form PF, hire compliance officers, have compliance manuals, comply with AIFMD, FATCA and a host of other regulatory burdens. As a result, firms formed prior to 2005 did perhaps have an overhead advantage over their newer brethren. Funds today don’t break even until they raise between $250 and $350 million in AUM, and barriers to entry have certainly grown. Add to this that more than 90% of capital has gone to funds with $1billion+ under management post-2008 and a manager would practically have to have perfectly aligned stars, impeccable performance and perhaps have made some sort of live sacrifice to achieve basic hedge fund dominance, let alone titan status.

This is not to say that newer funds haven’t made it into the “Billion Dollar Club” or that rarified air of 500 or so hedge funds that manage the bulk of investor assets. It is, however, a stark look at how we define expectations and success on both the investor and manager side of the equation. If 40 is the new 30 and orange is the new black, is $500 million or $1 billion in AUM the new yardstick for hedge funds? Time will tell, but I’m wondering if the Magic 8-Ball isn’t on to something. 

Dear Hedgie:

As a relatively new Tweeter (Twitterer?), I sometimes get questions from followers on a host of topics. In case you were also wondering, here are a few recent answers: Yes, there are almost always song lyrics hidden in my blogs. Actually, my hair is naturally large & no outside intervention is required. And yes, creating this much snark and sarcasm is exhausting.

Last week, I got the following question Tweeted in my general direction:

And while I can’t guarantee maximized profits, dear Tweeter, I can offer a few suggestions to enhance your first foray into alternative investments:

1. Take The Red Pill – The press loves, loves, loves them some alternative investments. And by loves, loves, loves I mean loathes, loathes, loathes. You’ve probably seen articles talking about excessive fees, billion dollar salaries, poor performance, insider trading, Ponzi schemes and other shenanigans and, I’m here to tell you, just because someone scribbled it on newsprint or online, doesn’t make it true. 

Take hedge funds, for example - they aren’t all gypsies, tramps and thieves, whatever you may have read. Fees are closer to 1.5% and 18% than to 2% & 20%. The vast majority of hedge fund managers make nowhere near the $11.3 billion that the 25 largest funds rake in, and are much more sensitive to reductions in fee income than you may think (see also http://www.aboutmjones.com/mjblog/2015/6/29/hedge-fund-truth-series-hedge-fund-fees). Insider trading happens, but is remarkably consistent at about 50 enforcement actions per year (across all miscreants, not just hedge funds). Ponzi schemes have happened but rarely at serious scale (and no, Madoff was not a hedge fund). Average performance of hedge funds has been lackluster but the top performers (who I’m pretty sure are the folks you want to invest with anyway) have generated some outstanding returns, even in the last few years. Don’t believe me? See the distribution of return graphics from Preqin’s latest study. 

Finally, there is no proof that hedge funds cause cancer, despite what the Hedge Clippers may say.

2.   Get a good data sample – One of the key mistakes I see from new investors in alternative investments, especially hedge funds, is the lack of a good data sample. The thing about hedge fund data is there is no requirement for any fund to report any information to any commercial hedge fund database. Period. As a result, the data is fragmented and incomplete. The only incentive for a fund to report to a database is to pursue assets. If a fund isn’t in asset raising mode, has a hearty network of prospective investors, or if the performance of fund is unlikely to attract assets, many funds simply won’t report. In addition, many funds report to only 1 or 2 databases, and if those don’t happen to be the ones to which you have access, well, that’s just tough cookies. The moral of the story? Invest in data. Buy data and gather information on your own by networking, going to conferences and talking to other investors about what and who they like. The only way to ensure you make the best investment decisions is to know what your options are in the first place.
 

3.   Think about what risk means to you – All too often, we try to boil risk down to a single data point. Whether it’s drawdown or standard deviation, we attempt to quantify risk because we feel like what we can quantify we can understand and control, right? Wrong. Risk means different things to different people and each investor will maximize different aspects of risks. For example, one investor may feel their biggest risk is not achieving a certain minimum acceptable return. Another may feel their biggest risk is losing a substantial amount of their investment. Yet another may feel headline risk is their biggest concern. And still another may worry about liquidity. The list is endless. The important thing for investors is to think about their personal (or organizational) definition of risk before making an investment, then identify the risks in any investment strategy as thoroughly as possible and finally determine if the potential upside is worth taking those risks. All investments involve risk. Period. Deciding whether the risk you’re taking is worth taking is up to you.

4.   Get your nose out of your DDQ – Get to know a manager and his or her team not just by grilling them with a long due diligence questionnaire, but by having a real conversation. If you know what’s important to a manager, what drives them, what keeps them up at night, how they got to where they are, what influences them, and how THEY perceive risk you have a much better chance of developing the rapport and trust that is necessary to any successful investment.

5.    Look ahead, not behind – If you’re chasing returns, you are already behind.

6.   Watch out for dry powder and Unicorpses – There is an awful lot of money flowing into private equity and venture capital and a finite number of reasonably priced deals, great management teams and fantastic business plans. Ensure any GP you plan to LP has the DL on deal flow.

7.   There is no I in TEAM – Actually, there is – it’s in the “A” holes. But I digress. My point is there is a lot of work associated with finding and doing due diligence and ongoing monitoring on alternative investments. If you don’t have a robust team, it’s ok to go to folks for help. Funds of funds, outsourced due diligence, OCIO, multi-family offices, operational due diligence firms, and other providers can be a lifesaver to a new or small investor in alternatives. It may not be cheap, but neither is recruiting, training and providing salary, bonus and benefits for an entire specialized team. Weigh what you can do in house against what you can easily outsource and spend the most effort on the voodoo that you do so well and money on the stuff that isn’t the best use of your time or expertise.

So there you have it: A small list of tips to help with first (or continued) forays into alternatives. Got a tip of your own? Put them in the comments section below.

Misusing These Popular Alternative Investment Terms? Inconceivable!

One of my favorite movies is The Princess Bride. Those of you that know me and my sense of humor probably aren’t surprised by that, but seriously, how can you NOT love a movie with R.O.U.S. (Rodents of Unusual Size), Miracle Max and a mysterious six-fingered man?

In fact, one of the best movie exchanges ever written probably appears in that movie. In it, the Dread Pirate Roberts is following Vizzini, Fezzik, and Inigo Montoya as they kidnap the titular princess, intent on malfeasance. 

Even as the Dread Pirate Roberts pursues them across an ocean of screaming eels and up the Cliffs of Insanity, Vizzini cries repeatedly that such actions are “Inconceivable!” Finally, Inigo Montoya declares: “You keep using that word. I do not think it means what you think it means.”

Comic gold? Absolutely.

Applicable to the alternative investment industry? Curiously, yes.

Recent interactions with various folks in the investment industry have led me to believe that Inigo may well have been speaking to us as well. In a number of cases, the words we use don’t mean what we think they mean. Perhaps we’ve selected them because they’re particular sexeh or they represent what we wish were true, rather than what is true, but regardless, we’re all sometimes guilty of creating a little linguistic anarchy by misusing investment terminology.

So, without further ado, and in no particular order, here are my top five investment terms that do not mean what we sometimes think they mean.

1. High Conviction and/or Concentrated– There is a growing body of research that supports the theory that high conviction portfolios generate higher returns. For example, a 2008 study from Harvard, the London School of Economic and Goldman Sachs found that, within U.S. Equity Mutual Funds, the highest conviction stocks outperformed the broad U.S. stock market and lower conviction stocks between 1 and 4 percent per quarter. Not too shabby. As a result, many investors like to see high conviction managers and many managers like to say they manage high conviction portfolios. But here’s a hint, it’s hard to have a portfolio of 50 high conviction positions. High conviction doesn’t just mean you LOVE your investments, it means you have fewer, larger positions, period. Which leads me to concentrated portfolios. As part and parcel of the High Conviction theme, I’ve come across an increasing number of managers who boast concentrated portfolios. Again, more than 50 positions does not a concentrated portfolio make. Take Warren Buffett for example. He usually has about 10 names in his book. Those keeping track, that’s conviction and concentration.
   
2. Unicorn – Merriam Webster defines a unicorn as “a mythical animal generally depicted with the body and head of a horse, the hind legs of a stag, the tail of a lion, and a single horn in the middle of the forehead.” The fact that it’s mythical means that the average Joe isn’t going to find a unicorn on his back porch eating the cat’s food anytime soon. In investing, a unicorn is a private company valued at $1 billion or more. As of March 2015, there were more than 80 unicorns according to CB Research, or just under the number from the prior three years combined. There are animals on the endangered species list with less population density. Perhaps we need a new term.
   
3. Emerging Manager – If you have a billion in AUM, and you’re not women, minority, or veteran owned, you are not an emerging manager. If you have $500 million in AUM, and you’re not women, minority, or veteran owned, you are not an emerging manager. If you have $250 million in AUM, and you’re not women, minority, or veteran owned, you are on the cusp (the top end) of being an emerging manager. If you are on Fund III, IV or V, and you’re not women, minority, or veteran owned, you are not an emerging manager.
   
4. Poor Performance – Underperforming an arbitrary and/or unrelated index is not an appropriate measure of performance. For example, comparing credit investments to the S&P 500. Comparing long-short equity investments to long only managers or long-only indexes. Determining whether something is good or bad relative to something else requires that the things being compared be largely similar to begin with.
   
5. Bottoms Up – “Bottoms up!” is a toast. Bottom-up is a way of analyzing information during the research process.

Seeing and hearing these terms misused in the investment industry makes my left eye twitch. Help save me from a lifetime of folks asking “Are you looking at me?” and start using these frequent used, but often abused, terms correctly.

Sources: http://www.globaleconomicandinvestmentanalytics.com/archiveslist/articles/499-the-case-for-high-conviction-investing.html, Merriam Webster, CB Insights

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

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

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. 

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 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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Are Hedge Clippers Trimming Up The Wrong Tree?

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

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

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

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

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

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

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

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

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

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

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

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

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