The Confidence - Hubris Conundrum

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

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

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

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

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

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

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

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

The Most Hated Profession on Earth

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

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

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

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

Memorial Day Hiatus

As you kick back this Memorial Day, eating BBQ and retrieving your white clothing from its long winter hibernation, take a moment to peruse past MJ Alts blogs. I'm taking the week off from blogging to enjoy the first gin and tonic of summer, eat some ribs and plant peppers in the back yard. I'll be back next week with another salty blog offering. 

Hedge Funding Kindergarten Teachers

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

(c) 2015 MJ Alternative Investment Research

The Crystal Ball in the Rearview Mirror

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

But I digress.

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

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

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

The Declaration of Fin-Dependence

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

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

It doesn't have to be this way. 

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

The Declaration of Fin-Dependence

Diversification and Alpha - By The Book

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

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

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

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

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

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

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

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

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

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

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

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

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

Available on Amazon.com and other book retailers.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Are Hedge Clippers Trimming Up The Wrong Tree?

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

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

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

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

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

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

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

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

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

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

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

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

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

7 Secrets to a Successful Fund "Elevator Pitch"

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

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

(c) MJ Alternative Investment Research LLC

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

Dear Showtime Execs, 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Yours truly,

MJ

Fun with Dots! Visualizing Trends in the Hedge Fund Industry

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

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

First, meet The Dot Fund, LLC. 

•  

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

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

The Hedge Fund Universe

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

The Billion Dollar Club Hedge Funds

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

Institutionally Defined “Emerging Managers”

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

Managers With Less Than $100m AUM

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

Annual Hedge Fund Closures

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

Diversity Hedge Funds

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

2014 Estimated Asset Flows into Hedge Funds

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

Fund Flows Into Large Hedge Funds

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

Fund Flows Into Emerging Hedge Funds

Not a pretty picture, eh?

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

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

Cash Return Differential 1999-2011

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

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

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

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

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

Source: The New York Times

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

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

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

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

But I digress.

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

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

@MJ Alts

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(c) MJ Alts

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

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

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

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

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

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

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

The Hedge Fund Truth - Launching and Running a Small Fund

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

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