Bull market
Bull market? Financial planning is about reliably achieving client goals. Good hedge funds have delivered superbly unlike the journeymen at long only shops. Over 3,000 hedge funds had POSITIVE returns in 2008. How many long only equity managers? It's best to invest in quality so I'll stay in the safe haven of skill-based strategies. Every institution I deal with is INCREASING investment in alpha. The hedge fund industry is stronger than ever despite "experts" predicting its demise...again.
Passive is high risk. 2008 was a GREAT year for truly diversified portfolios. Volatility creates opportunity. The future prospects for good hedge funds are outstanding. Bonds have outperformed stocks for a long time but skill has done far better. The SKILL premium exists but the equity RISK premium? Naive to expect to be paid for exposure to risky asset classes over the long term. People prefer managers that avoid big losses. The epochal change is from long only assets to long short strategies.
Stock indices tracked by "passive" managers might get back to where they once were. But even if I was certain that in 2030 the Dow, Nikkei, DAX and FTSE will all be above 100,000, I still won't be gambling on long only equity. I know with certainty that hedge funds will have HIGHER risk-adjusted returns. If those benchmarks turn out to be LOWER than today, good hedge funds will also have outperformed. Quality strategies are a win/win for investors wishing to grow and preserve their capital.
Recessions are bad for beta but good for alpha. Diversified ROBUST hedge fund portfolios beat stock benchmarks on a risk-adjusted basis over all time horizons. Long only equity funds squandered a disasterous -40% in 2008 and remain negative for the decade. Despite a drawdown, even an index of "all" hedge funds produced +22% alpha compared to the stock market. The biggest risk most investors take is the outdated infatuation and uncompensated mania for the unhedged stock market.
Very rare "hedge funds" that imploded receives saturated media coverage but there have not been many articles on the managers that made +20%, some over +100%, last year. Change is a constant in finance and doesn't faze those with genuine acumen. The "average" fund manager is just that, AVERAGE. The "indices" indicate little with such wide performance dispersion.
Demand for absolute return is growing unlike that unrequited love affair with stocks that has jilted so many investors. The long only luddites hope risk appetite will rise again but skilled long/short strategies offer a smoother ride. "Buy and hold" has been an acarpous wasteland for too long. Like many investors, I NEVER have an appetite for such risky speculation.
But I do have the simple yet novel requirement that fund managers make money in USEFUL time frames without devastating drawdowns. Anyone who regularly meets with proper hedge funds and bothers to look closely at the performance data concludes that the more conservative an investor's risk tolerance, the MORE of their portfolio they need in proper hedge funds. Long only equity losses of -50% are beyond any acceptable level of risk with +100% needed just to get back to breakeven. The empirical evidence PROVES the lower risk and higher performance of good hedge funds. Many of the largest institutional investors are EXPANDING their hedge fund investments. Individual investors would be prudent to follow.
80% of alpha is made by 20% of managers. The Pareto principle governs hedge funds too. There is nothing unexpected about recent "aggregate" numbers and good hedge funds continue to produce EXACTLY what they promised - uncorrelated absolute returns with capital preservation. Portable alpha redistributes from the unskilled to those with an edge. Back in 1970, 2 out of 3 "hedge funds" shut down but the following 40 years saw a LOT of growth. 1994 and 1998 were also supposedly the "end" of hedge funds. The current blip is another temporary timeout in the ongoing expansion of the hedge fund industry. Any money withdrawn creates more space for smarter investors.
The ONLY hedge for a long is a short. Why should bull markets or bear markets affect the capital growth of a truly diversified portfolio? Asset allocation has not met the expectations of investors. As this decade showed, if you own lots of stocks, bonds, real estate, private equity and commodities you are NOT sufficiently diversified. Long only risky assets are correlated, particularly in bear markets. A robust portfolio requires substantial investment in orthogonal skill-based strategies that do not depend on rising markets or a strong economy for performance. Diversification with lots of different strategies is critical to optimal portfolio construction for the long term.
Not investing in any stock or corporate bond because of Bernie Ebbers would be dumb so why are some arguing for avoiding absolute return strategies because of a fraudulent stockbroker called Bernie Madoff? That would be almost as silly as eschewing honest funds of funds that actually conduct due diligence because of Bernie Cornfeld. One of the best hedge fund managers was Bernie Baruch. If only we had access to his perspicacity today like President Roosevelt did during the 1930s depression. It is hazardous to rely on economists to advise on the economy and we shall see if the PPIP succeeds. Is government leverage the solution to ineffective use of leverage?
Long only funds are not for those who dislike riding the stock market rollercoaster. Long term absolute returns are the raison d'etre and why anyone would invest in an AVERAGE hedge fund is incomprehensible to me. It's almost as weird as wasting time and money in an "average" stock. With the right evaluation techniques, investors can do a LOT better than "alternative beta" just as they can with market beta. Traditional 60/40 stocks and bonds just doesn't work. Keep it simple - overweight alpha in your portfolio. It's safer and more reliable. Don't bet on beta and avoid any "hedge funds" or "mutual" funds that depend on it.
The redemption of hot money creates more room for investors who understand that smaller AUMs lead to larger alphas. Poor quality "hedge funds" that shut down will simply be replaced by better new ones. The "free lunch" of "passive" index funds has cost investors too much money for far too long. The CULT of equity and the credit cataclysm have devastated beta-centric portfolios. The CURE is to rebalance in favor of investment skill. Not long from now hedge funds will be a CORE component of all investment portfolios. Risky asset classes are too volatile and need to be hedged.
Good hedge funds continue to generate the performance that investors need and have done that throughout the equity tumult and credit induced economic turmoil. There is a terrific pipeline of NEW strategies and hedge funds coming. Did the dot.com implosion end internet usage? For each Netscape, Excite and Pets.com along came a Google, Facebook and Twitter. Creative destruction and innovation drives investment technology too. Good riddance to the dinosaurs; welcome to evolving ways of making money. Many investors are aligning their interests with talented and incentivized fund managers that focus on risk-adjusted returns.
The stigma of high sigma renders unhedged equity funds unsuitable for those who seek reliable performance at low volatility. The blandiloquence of the index fund aficionados with their "cheap" fees but expensive losses has not helped investors. The FACT that equities have underperformed bonds over such long periods refutes the "Nobel" prize winning dogma. Stocks constitute an opportunity set of securities to buy and short sell. The mythical equity risk premium doesn't exist. For persistent alpha generation, you need a better data set and better ways of extracting information from that data set. Hedge funds are NOT an asset class; they are skilled strategies applied within and between asset classes.
Redemptions? Sure some cash is being transitioned since manager mixes are being upgraded. You must redeem from the underperformers before you can reinvest in the better hedge funds. It is also great news for the new money that will be coming in. The removal of the beta repackagers, that pretended to be "hedge funds" but got blown away by the market meltdown, improves the quality of the industry. Isn't that how capitalism is supposed to work? Doesn't the cull of the bottom quartiles IMPROVE the overall standard? Some people are redeeming for liquidity reasons due to losses in public and private equity. When "hot money" is taken from good hedge funds for ATM purposes, it creates more room for stable long term money.
Investors care about performance, not asset gathering accolades, so why is a reduced AUM a "bad" thing given that it is likely to lead to INCREASED performance? Smaller sized hedge funds and a superior manager universe means HIGHER returns and less crowded trades. There are MORE arbitrages, dislocations, anomalies and mispricings around for those with the ability to find them than ever before. As we saw with previous "death of hedge fund" predictions, shaking out the losers is good for the absolute return industry and even better for investors.
Public scrutiny of "secretive", "swashbuckling", "unregulated" hedge funds is fine as long as it also brings public availability. Some countries' regulators have not permitted those who they deem "unsophisticated" to invest in hedge funds. Rarely have the FORWARD-LOOKING alpha opportunities been brighter and who can afford to endure the damage of "passive" beta again? The volatility has eliminated funds with poor risk management processes while the departure of short term money has expanded the capacity available for investors that understand the diversification value of good hedge funds. The shakeout is a POSITIVE for those seeking alpha.
The more unsophisticated money that departs creates more room for people that appreciate the RISK REDUCTION properties of good hedge funds. Alpha-centric portfolios require skilled security selection and risk management. Since skill is rare and performance dispersion wide, strategy analysis, manager evaluation and portfolio optimization adds more alpha. No-one claims investing in hedge funds is simple. Index funds are easy to understand but "passive" performance has been poor.
Aggregate returns when the hedge fund industry was smaller were higher. Robust strategies have capacity and implementation constraints so a lower AUM is good for performance. Changes in the financial markets? Sure but the best managers adapt to any conditions. Variant perception and negative sentiment creates opportunities for those who do the hard work and analytical heavy lifting to find the value through the blind hysteria and non-expert opinion. The wisdom of crowds often results in wealth destruction. As last year showed, the zero sum alpha game means lots of people will be wrong. The animal spirit of the markets inevitably results in some winners but more losers. If "everyone" is making money then something is broken.
Time is worth more than money so I shall not be waiting around for stock markets to recover when so many talented managers are at or near their high water marks NOW. With better solutions available, why endure the deadly drawdowns, vicious volatility and ridiculous risk of the stock market? Life is short and liabilities grow so who has decades available to await the alleged upward drift of the index? Reliable long term returns requires attention to short term risk.
In the worst bear markets there are always good stocks and there are plenty of short sell candidates during bull markets. Long only index based investing guarantees too much money flows to bad stocks. Tracking a benchmark means the same HIGH risk as the benchmark is taken. Equity capital should flow to good companies; not ones that "have to be bought" because someone else actively decided to include them in their "passive" benchmark.
By replacing market risk with manager risk, investors get reliable growth with capital preservation irrespective of underlying market direction. If they diversify, do their homework and are advised properly, investors DO get compensated for taking good hedge fund manager risk but they have NOT been paid for taking stock market risk. Individual investors need absolute returns in reasonable time frames. Whether you have $1,000 or $1 trillion to put to work, a substantial allocation to absolute return strategies is ESSENTIAL. Investors need performance whatever the economic situation. In fact they need it even more in tough economic times.
Some believe that by holding on long enough, traditional portfolios will be fine. Economists rarely let the facts get in the way of their assumptions. The long only crowd claim that by staying in for the "long haul", UNHEDGED funds are all your portfolio needs. Conversely anyone who studies PROPER hedge funds sees their overwhelming superiority and safety. The critics know little about hedge funds and have usually never invested in one themselves but still think their views are valid. Finance has changed; the dubious mantra of buy and hold ended last century.
No place to hide? Actually there have been plenty of places to hide during the market turbulence. For managed futures CTAs, options traders and short biased strategies, 2008 was an outstanding year. Cash isn't king when it yields zero. Traditional asset allocation simply hasn't worked very well; skill based security selection with strategies that DIVERSIFY are what work. If an investor wants RELIABLE growth at limited risk in any forward looking market scenario, a well constructed portfolio of bona fide hedge funds running DIFFERENT strategies is the way to achieve it.
Stay the course? But what course is the economy on in the long term? How should one invest given that we do NOT know future market conditions? Why the stoic indifference to portfolio pain when proven antidotes are available? The answer is with the absolute return managers that have the talent and incentives to make money irrespective of market direction. Modern portfolio theory doesn't need a tweak; it needs an extreme makeover. Any manager that loses -50% TWICE in a decade does not merit a place in any risk averse portfolio so sayonara to long only "passive" funds. Speculating on the noxious notion that stock markets "rise over time" isn't suitable for those who need performance in sensible time frames. Even in bull markets the RETURN ON RISK of index funds is very low.
Bull market? Yes it's always a bull market for investment EXPERTISE. Traditional investors urgently need to access that talent. A SUBSTANTIAL allocation to diversified skill based absolute return strategies is necessary for risk averse investors.
Passive is high risk. 2008 was a GREAT year for truly diversified portfolios. Volatility creates opportunity. The future prospects for good hedge funds are outstanding. Bonds have outperformed stocks for a long time but skill has done far better. The SKILL premium exists but the equity RISK premium? Naive to expect to be paid for exposure to risky asset classes over the long term. People prefer managers that avoid big losses. The epochal change is from long only assets to long short strategies.
Stock indices tracked by "passive" managers might get back to where they once were. But even if I was certain that in 2030 the Dow, Nikkei, DAX and FTSE will all be above 100,000, I still won't be gambling on long only equity. I know with certainty that hedge funds will have HIGHER risk-adjusted returns. If those benchmarks turn out to be LOWER than today, good hedge funds will also have outperformed. Quality strategies are a win/win for investors wishing to grow and preserve their capital.
Recessions are bad for beta but good for alpha. Diversified ROBUST hedge fund portfolios beat stock benchmarks on a risk-adjusted basis over all time horizons. Long only equity funds squandered a disasterous -40% in 2008 and remain negative for the decade. Despite a drawdown, even an index of "all" hedge funds produced +22% alpha compared to the stock market. The biggest risk most investors take is the outdated infatuation and uncompensated mania for the unhedged stock market.
Very rare "hedge funds" that imploded receives saturated media coverage but there have not been many articles on the managers that made +20%, some over +100%, last year. Change is a constant in finance and doesn't faze those with genuine acumen. The "average" fund manager is just that, AVERAGE. The "indices" indicate little with such wide performance dispersion.
Demand for absolute return is growing unlike that unrequited love affair with stocks that has jilted so many investors. The long only luddites hope risk appetite will rise again but skilled long/short strategies offer a smoother ride. "Buy and hold" has been an acarpous wasteland for too long. Like many investors, I NEVER have an appetite for such risky speculation.
But I do have the simple yet novel requirement that fund managers make money in USEFUL time frames without devastating drawdowns. Anyone who regularly meets with proper hedge funds and bothers to look closely at the performance data concludes that the more conservative an investor's risk tolerance, the MORE of their portfolio they need in proper hedge funds. Long only equity losses of -50% are beyond any acceptable level of risk with +100% needed just to get back to breakeven. The empirical evidence PROVES the lower risk and higher performance of good hedge funds. Many of the largest institutional investors are EXPANDING their hedge fund investments. Individual investors would be prudent to follow.
80% of alpha is made by 20% of managers. The Pareto principle governs hedge funds too. There is nothing unexpected about recent "aggregate" numbers and good hedge funds continue to produce EXACTLY what they promised - uncorrelated absolute returns with capital preservation. Portable alpha redistributes from the unskilled to those with an edge. Back in 1970, 2 out of 3 "hedge funds" shut down but the following 40 years saw a LOT of growth. 1994 and 1998 were also supposedly the "end" of hedge funds. The current blip is another temporary timeout in the ongoing expansion of the hedge fund industry. Any money withdrawn creates more space for smarter investors.
The ONLY hedge for a long is a short. Why should bull markets or bear markets affect the capital growth of a truly diversified portfolio? Asset allocation has not met the expectations of investors. As this decade showed, if you own lots of stocks, bonds, real estate, private equity and commodities you are NOT sufficiently diversified. Long only risky assets are correlated, particularly in bear markets. A robust portfolio requires substantial investment in orthogonal skill-based strategies that do not depend on rising markets or a strong economy for performance. Diversification with lots of different strategies is critical to optimal portfolio construction for the long term.
Not investing in any stock or corporate bond because of Bernie Ebbers would be dumb so why are some arguing for avoiding absolute return strategies because of a fraudulent stockbroker called Bernie Madoff? That would be almost as silly as eschewing honest funds of funds that actually conduct due diligence because of Bernie Cornfeld. One of the best hedge fund managers was Bernie Baruch. If only we had access to his perspicacity today like President Roosevelt did during the 1930s depression. It is hazardous to rely on economists to advise on the economy and we shall see if the PPIP succeeds. Is government leverage the solution to ineffective use of leverage?
Long only funds are not for those who dislike riding the stock market rollercoaster. Long term absolute returns are the raison d'etre and why anyone would invest in an AVERAGE hedge fund is incomprehensible to me. It's almost as weird as wasting time and money in an "average" stock. With the right evaluation techniques, investors can do a LOT better than "alternative beta" just as they can with market beta. Traditional 60/40 stocks and bonds just doesn't work. Keep it simple - overweight alpha in your portfolio. It's safer and more reliable. Don't bet on beta and avoid any "hedge funds" or "mutual" funds that depend on it.
The redemption of hot money creates more room for investors who understand that smaller AUMs lead to larger alphas. Poor quality "hedge funds" that shut down will simply be replaced by better new ones. The "free lunch" of "passive" index funds has cost investors too much money for far too long. The CULT of equity and the credit cataclysm have devastated beta-centric portfolios. The CURE is to rebalance in favor of investment skill. Not long from now hedge funds will be a CORE component of all investment portfolios. Risky asset classes are too volatile and need to be hedged.
Good hedge funds continue to generate the performance that investors need and have done that throughout the equity tumult and credit induced economic turmoil. There is a terrific pipeline of NEW strategies and hedge funds coming. Did the dot.com implosion end internet usage? For each Netscape, Excite and Pets.com along came a Google, Facebook and Twitter. Creative destruction and innovation drives investment technology too. Good riddance to the dinosaurs; welcome to evolving ways of making money. Many investors are aligning their interests with talented and incentivized fund managers that focus on risk-adjusted returns.
The stigma of high sigma renders unhedged equity funds unsuitable for those who seek reliable performance at low volatility. The blandiloquence of the index fund aficionados with their "cheap" fees but expensive losses has not helped investors. The FACT that equities have underperformed bonds over such long periods refutes the "Nobel" prize winning dogma. Stocks constitute an opportunity set of securities to buy and short sell. The mythical equity risk premium doesn't exist. For persistent alpha generation, you need a better data set and better ways of extracting information from that data set. Hedge funds are NOT an asset class; they are skilled strategies applied within and between asset classes.
Redemptions? Sure some cash is being transitioned since manager mixes are being upgraded. You must redeem from the underperformers before you can reinvest in the better hedge funds. It is also great news for the new money that will be coming in. The removal of the beta repackagers, that pretended to be "hedge funds" but got blown away by the market meltdown, improves the quality of the industry. Isn't that how capitalism is supposed to work? Doesn't the cull of the bottom quartiles IMPROVE the overall standard? Some people are redeeming for liquidity reasons due to losses in public and private equity. When "hot money" is taken from good hedge funds for ATM purposes, it creates more room for stable long term money.
Investors care about performance, not asset gathering accolades, so why is a reduced AUM a "bad" thing given that it is likely to lead to INCREASED performance? Smaller sized hedge funds and a superior manager universe means HIGHER returns and less crowded trades. There are MORE arbitrages, dislocations, anomalies and mispricings around for those with the ability to find them than ever before. As we saw with previous "death of hedge fund" predictions, shaking out the losers is good for the absolute return industry and even better for investors.
Public scrutiny of "secretive", "swashbuckling", "unregulated" hedge funds is fine as long as it also brings public availability. Some countries' regulators have not permitted those who they deem "unsophisticated" to invest in hedge funds. Rarely have the FORWARD-LOOKING alpha opportunities been brighter and who can afford to endure the damage of "passive" beta again? The volatility has eliminated funds with poor risk management processes while the departure of short term money has expanded the capacity available for investors that understand the diversification value of good hedge funds. The shakeout is a POSITIVE for those seeking alpha.
The more unsophisticated money that departs creates more room for people that appreciate the RISK REDUCTION properties of good hedge funds. Alpha-centric portfolios require skilled security selection and risk management. Since skill is rare and performance dispersion wide, strategy analysis, manager evaluation and portfolio optimization adds more alpha. No-one claims investing in hedge funds is simple. Index funds are easy to understand but "passive" performance has been poor.
Aggregate returns when the hedge fund industry was smaller were higher. Robust strategies have capacity and implementation constraints so a lower AUM is good for performance. Changes in the financial markets? Sure but the best managers adapt to any conditions. Variant perception and negative sentiment creates opportunities for those who do the hard work and analytical heavy lifting to find the value through the blind hysteria and non-expert opinion. The wisdom of crowds often results in wealth destruction. As last year showed, the zero sum alpha game means lots of people will be wrong. The animal spirit of the markets inevitably results in some winners but more losers. If "everyone" is making money then something is broken.
Time is worth more than money so I shall not be waiting around for stock markets to recover when so many talented managers are at or near their high water marks NOW. With better solutions available, why endure the deadly drawdowns, vicious volatility and ridiculous risk of the stock market? Life is short and liabilities grow so who has decades available to await the alleged upward drift of the index? Reliable long term returns requires attention to short term risk.
In the worst bear markets there are always good stocks and there are plenty of short sell candidates during bull markets. Long only index based investing guarantees too much money flows to bad stocks. Tracking a benchmark means the same HIGH risk as the benchmark is taken. Equity capital should flow to good companies; not ones that "have to be bought" because someone else actively decided to include them in their "passive" benchmark.
By replacing market risk with manager risk, investors get reliable growth with capital preservation irrespective of underlying market direction. If they diversify, do their homework and are advised properly, investors DO get compensated for taking good hedge fund manager risk but they have NOT been paid for taking stock market risk. Individual investors need absolute returns in reasonable time frames. Whether you have $1,000 or $1 trillion to put to work, a substantial allocation to absolute return strategies is ESSENTIAL. Investors need performance whatever the economic situation. In fact they need it even more in tough economic times.
Some believe that by holding on long enough, traditional portfolios will be fine. Economists rarely let the facts get in the way of their assumptions. The long only crowd claim that by staying in for the "long haul", UNHEDGED funds are all your portfolio needs. Conversely anyone who studies PROPER hedge funds sees their overwhelming superiority and safety. The critics know little about hedge funds and have usually never invested in one themselves but still think their views are valid. Finance has changed; the dubious mantra of buy and hold ended last century.
No place to hide? Actually there have been plenty of places to hide during the market turbulence. For managed futures CTAs, options traders and short biased strategies, 2008 was an outstanding year. Cash isn't king when it yields zero. Traditional asset allocation simply hasn't worked very well; skill based security selection with strategies that DIVERSIFY are what work. If an investor wants RELIABLE growth at limited risk in any forward looking market scenario, a well constructed portfolio of bona fide hedge funds running DIFFERENT strategies is the way to achieve it.
Stay the course? But what course is the economy on in the long term? How should one invest given that we do NOT know future market conditions? Why the stoic indifference to portfolio pain when proven antidotes are available? The answer is with the absolute return managers that have the talent and incentives to make money irrespective of market direction. Modern portfolio theory doesn't need a tweak; it needs an extreme makeover. Any manager that loses -50% TWICE in a decade does not merit a place in any risk averse portfolio so sayonara to long only "passive" funds. Speculating on the noxious notion that stock markets "rise over time" isn't suitable for those who need performance in sensible time frames. Even in bull markets the RETURN ON RISK of index funds is very low.
Bull market? Yes it's always a bull market for investment EXPERTISE. Traditional investors urgently need to access that talent. A SUBSTANTIAL allocation to diversified skill based absolute return strategies is necessary for risk averse investors.
© posted by Hedge Fund on 3:08 AM
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