Hedge funds for the masses

Tired of the same boring mutual funds? Want some hedge fund action but don't have the $5 million minimum initial investment? Now there is a product for you - a mutual fund of hedge funds called the Blackstone Alternative Multi-Manager Fund. Among others, here are the managers to whom your capital would be allocated.

 Two Sigma Advisers
 Cerberus Sub-Advisory
 Credit Suisse Hedging-Griffo Servios Internacionais
 HealthCor Management
 Caspian Capital
 Boussard and Gavaudan Asset Management
 Wellington Management
 Good Hill Partners
 BTG Pactual Asset Management
 Chatham Asset Management
 Nephila Capital

And just like in a typical mutual fund you get daily liquidity, except for those pesky early redemption fees. As far as disclosure, Blackstone doesn't want the world to know what fee split arrangement it has with these hedge fund managers (sub-advisors) and will only disclose the aggregate fee.

From the SEC filing: - Applicants also request an order exempting the Subadvised Series from certain disclosure obligations that may require each Subadvised Series to disclose fees paid by the Advisor to each Sub-Advisor. 

The portfolio is a mix of strategies including distressed credit, black box equity investing, long/short credit, various emerging markets, structured products, etc. It's all the stuff that retail investors wanted to know about but were afraid to ask.

Now that institutional investors are not stepping up to hedge fund investing the way they used to, it's time to tap the retail universe.




Blackstone mutual fund of hedge funds

SoberLook.com

From our sponsor:

Hedge funds punished for being too defensive

After performing poorly in 2011 (see this discussion), hedge funds on average are barely up for the year. Many loaded up on sovereign CDS protection in preparation for the Eurozone mess worsening, but got blown out by Draghi's "save the euro" campaign (see discussion). Some maintained large cash positions or significant short equity/credit exposures, all of which resulted in underperformance.

Broad hedge fund index (CS/DJ) vs S&P500 (through 9/7/12)

Being defensive (on top of charging high fees) simply has not been a "winning" strategy lately. It's difficult to actively manage assets based on the whims of central banks rather than economic fundamentals.

FINalternatives: - “Hedge funds continue to learn a hard lesson,” added Gradante. “‘Don't fight the Fed… Regardless of Fundamentals’ should be the bumper sticker for this market. Sitting in cash, being defensive and waiting for the other shoe to drop has been a poor strategy during the last 12 months.”

Some investors simply have had enough of poor performance and are starting to redeem.

Reuters: - Investors took more money away from hedge funds in July when they asked for $7.4 billion back, underscoring their frustration with an industry that has long promised to make money in all markets but is currently delivering only middling returns.

July's redemption requests were up sharply from the $4.2 billion pulled out in June, according to data released by BarclayHedge and TrimTabs Investment Research on Tuesday [Sept. 11]. That leaves hedge funds industry assets at roughly $1.87 trillion, down 23 percent from their peak four years ago before the financial crisis hit, the research report found.

"We've seen a notable reversal in hedge fund industry fortunes during the past year," said Sol Waksman, founder and president of BarclayHedge.

This is troubling news in an industry dwarfed in size by the mutual fund industry but able to attract some of the world's savviest investors with the promises of big paychecks and more investing freedoms.

SoberLook.com

Market neutral vs. quant funds - recent trends

A couple of trends have been developing in the hedge fund space that are worth noting. It seems that institutional investors (and fund of funds managers) continue to support the so-called "market neutral" strategies. Typically these funds will run a leveraged portfolio on a gross basis but try to neutralize it via long/short stocks or stock indices. They tend to use various beta weighted measurements to determine how stocks will respond to market movements in order to construct what they view as a "neutral" book. It becomes an "outperformance" game. Given how equity markets have behaved in recent years with historical beta assumptions often breaking dawn, it's not surprising that these funds have not done well recently.

Source: HFR

However they've done better than other hedge funds in 2011, which apparently makes them interesting to investors. Some institutions are viewing this group of funds as having low (or no) correlation to the overall equity markets or the hedge fund space in general. It's not clear if this is entirely true, but it helps pension managers sleep better at night. So these funds have been proliferating in spite of poor performance.

Number of Surviving Market Neutral Funds, Annually, 2000 - 2012 (source: Credit Suisse)

On the other hand the so-called "Quantitative" (Quant) directional strategies (with Renaissance Technologies being the most famous) have been on a decline. Many investors do not believe these strategies are sustainable, as more computer-driven funds would pile into the same trades, distorting markets. Over the past 5 years Quant funds are still down on average (though returns have improved this year). With rising risks to changes in algorithmic trading rules that could negatively impact these strategies, many institutional investors are walking away.

Number of Surviving Quant Funds, Annually, 1995 - 2012 (source: Credit Suisse)

SoberLook.com

Before starting a hedge fund, read this

For anyone starting a hedge fund, this document called "A Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures" from the Alternative Investment Management Association is a must-read. This is what institutional investors are now demanding from hedge funds. The better a fund is set up to meet institutional investor needs, the higher are its chances for success. In the current environment institutions such as pensions and endowments have enormous clout over hedge funds, particularly over those who have not been around for very long. And they will make their needs known.

Therefore this list of requirements from institutions should be viewed as "best practices" by a fund manager. The customer is always right, and the largest customers, are even more right. Here is an example of the typical requirements institutions now ask for - in this case when addressing transparency:

• Management fees should be designed to cover operating costs. 
• Performance fees should be structured in a manner consistent with the underlying strategy, investment horizon and liquidity including, where appropriate, the crystallisation of some portion of the fee over several periods.
• Business model should be designed to retain majority of investment and management talent when the fund is below the high-water mark for more than a year.
• Control of assets so that the investor has the ability to receive most, if not all, of its capital within a year or less with minimal, if any, constraints.
• Transparency that is sufficient for the client to understand the hedge fund exposures and the risks taken in the portfolio, as well as performance drivers.
• Transparency so that the investor receives security level information that can be used in a risk analytics tool.

These types of transparency requirements were unheard of a few years ago.  But times have changed dramatically for the industry and "a couple of guys in a garage" starting a hedge fund will no longer fly. 

Enjoy.

A Guide to Institutional Investors’ Views and Preferences Regarding Hedge Fund Operational Infrastructures

SoberLook.com

Madoff in the face of the SEC

Just to add to our post on hedge fund regulation, here is a paper sent to the SEC in November of 2005. It outlinces potential problems with the Madoff funds in great detail. A simple inquiry to the fund accountants would have done the trick.

This was in your face type analysis: the SEC was fed the questions; they just had to ask them. So what exactly will the SEC accomplish with the new sweeping registration requirements? Has the agency really changed so much that now all of a sudden it will spot problems like these? How about listening to what investment professionals are saying? How about hiring a few investment professionals instead of just the securities attorneys? How about just looking at return profiles? The new financial regulation proposed by the administration is just not addressing these.

The rapidly shifting hedge fund regulation

Here is a thorough write-up from PWC on hedge fund regulation changes in the various jurisdictions. They particularly focus on issues with the new European hedge fund regulation. Three items are worth discussing:

1. The new EU regulations will require funds to have an independent valuation agent every time there is a subscription or redemption from a fund. It’s a great rule in theory, but good luck finding expert valuation agents in Europe for the less liquid fixed income assets. This will blow out most illiquid funds, putting macro players on top.

2. All funds need to have a depository for all the assets that is an EU credit institution. This will exclude most existing prime brokers – there are only 4 that are based in EU. That means you have to go to some sleepy European bank and ask them to be an intermediary between you (the hedge fund) and a real prime broker. Good luck reconciling margin, cash, and positions on a daily basis. Ouch.

3. There is a requirement to disclose leverage. Assuming there are sensible rules to do so, it wouldn’t be an issue. However no rules are provided. Here is an example: you are a payer of floating on a 3-year interest rate swap and a payer of fixed on a 10-year swap (at different nationals that make you duration neutral). It’s what’s called a “steepener” trade. How should you measure leverage on something like this? – good luck getting a sensible consistent answer from a regulator.

Those who find a way to cope with these will quickly dominate the space.

And just a quick note for all of you out there that want to regulate everything. Hedge funds and private equity firms did not cause the financial crisis. Many were hurt by it, a few got destroyed.

Citibank was regulated by the Fed, Lehman was regulated by the SEC, and AIG was regulated by the states of NY and CT, the Office of Thrift Supervision, and by the UK FSA.

So here is the ultimate question: how did these regulators do?
We need smart and consistent regulation, not more of it.