Wednesday, February 29, 2012

Hedge Funds Back in the Balance?

Pension Funds Insider reports, Hedge funds back in the balance for pension fund trustees:

A Deutsche Bank survey indicates that pension fund trustees are becoming increasingly sure of the merits of hedge fund investing, despite a disappointing year for the industry's returns.

The firm's annual international survey of hedge fund investors found that only 16% of respondents cited trustees and their boards' views on hedge funds as the biggest impediment to further increasing their hedge fund portfolios, down significantly from 30% in 2011.

The same survey indicated that 38% of investors trustee boards strongly believe in the validity of hedge funds as an investing tool.

That is an increase from 25% fully-fledged hedge fund fans in 2011, which Anita Nemes, Deutsche Bank's global head of capital introduction and report author, explained to Pension Funds Insider was most likely due to experience and the growing institutional offering that hedge funds provide.

The survey reinforced the much noticed institutionalisation of the hedge fund industry. This has been a clear trend since the financial crisis as hedge funds become increasingly appreciative of the advantages of attracting stable long-term investment from pension funds and other institutional investors.

Over one-third of this year's survey respondent were end institutional investors (excluding fund of funds, many of which are also institutional) compared to 11% in 2002.

Nemes told Pension Funds Insider that hedge funds are "an active way of managing risk rather than just another asset class. Anybody with a funding gap will want to invest in dampening volatility and protect from the downside".

The number of investors who said that 30 percent or more of their managers have not reached the high watermark has doubled.

Nemes said that performance and better risk adjusted returns continue to be the main benefit of hedge fund investing, therefore its critical the industry has good performance in 2012.

For many observers performance worries remain a big caveat to the increasing flows of pension money into the industry.

Nemes said "performance will never go out of fashion of course. The only reason anyone invests in a hedge fund is that they are looking for better returns."

Nemes believes that consolidation in the hedge fund industry is likely in the next year. It seems that could be given extra momentum by a wide variation in returns.

She doesn't share concerns about large hedge funds being naturally poorer performers than smaller ones, saying "size can be a problem as it's difficult to be nimble with huge numbers of assets but if you look at the industry on the whole you really can't generalise – some large hedge funds produced fantastic returns last year."

With 80% of institutional investors responding to the survey admitting to have increased their hedge fund investments over the past year, there looks likely to be rich pickings for those hedge funds able to thrive and expand in the current environment.

Strangers no more

A further indication of the increasingly pivotal role played by institutional investors like pension funds in the hedge fund industry is that pension fund trustees now largely see eye-to-eye with star hedge fund managers when it comes to the vital issue of transparency.

70% of respondents to the Deutsche Bank survey say they are satisfied with transparency. Nemes said: "That number used to be much lower and I think that is because hedge funds have become a lot more open, but a lot of pension funds are perhaps also realising what data it is they really need from a hedge fund they invest in."

Nemes said pension fund trustees might have begun to accept that there is no point always asking for full position level disclosure from a hedge fund and are instead focusing on understanding where their returns come from with profit and loss attributions and risk analytics.

Nemes added: "Pension funds are OK in paying two and twenty for alpha but they are not happy with paying two and twenty for beta so they want to be reassured on that."
Not happy paying 2 & 20 for beta? That's exactly what most pension funds are doing at a time when most hedge funds are drowning in high water hell.

As far as position level transparency, most pension funds don't want it because of liability issues. Moreover, even if they had it, they wouldn't know what to do with it. Sophisticated pension funds in Canada and elsewhere are opting for position level transparency, using a managed account platform, exercising full control over the portfolio. But they are the exception to the rule. Most pension funds just write a big check and accept the NAV that hedge funds send them along in their monthly commentary.

All this talk of risk transparency is fluffed up nonsense. Any pension trustee that accepts this garbage deserves to get their hand handed to them.
It's great for lazy pension fund managers who want to appear like they are managing risk of their hedge fund portfolio but it's utter nonsense. Risk transparency means nothing unless you have it real time and can act on it quickly. Remember the flipside of transparency is liquidity. You can have all the transparency in the world but if you can't act on it, it's useless.

As far as large hedge funds, there is a placebo effect. Some of them are performing exceptionally well while others are grossly underperforming. Bloomberg reports, Dalio Earned Clients $13.8 Billion to Lead Hedge Funds as Paulson Slumped:

Ray Dalio’s Pure Alpha hedge fund made $13.8 billion for its investors last year, while John Paulson lost clients almost $10 billion after an unsuccessful wager that the U.S. economy would recover, according to a report by LCH Investments NV.

Pure Alpha, part of Dalio’s Bridgewater Associates LP, has earned $35.8 billion for investors since its inception in 1975, said LCH, a firm overseen by the Edmond de Rothschild Group. Losses for New York-based Paulson & Co. last year cut gains the firm has made for clients since its 1994 founding to $22.6 billion, LCH estimated.

Dalio’s Pure Alpha II ran up a 23.5 percent gain in the first 10 months of the year. The manager, 62, had three of the industry’s 12 best-performing funds, Bloomberg Markets reported in its February issue. The firm charges 2 percent of assets as a management fee and gets 20 percent of profits.

Bridgewater, based in Westport, Connecticut, has about $120 billion of assets and uses a macro strategy to try to profit from economic trends. It placed diversified bets in 2011 after predicting a flight by other investors to safer assets such as U.S. Treasuries and German bonds, standing out in a year when hedge funds lost 5.2 percent on average, according to data compiled by Bloomberg. Paulson posted a record loss of 51 percent in one of his biggest funds.

“Macro investing is notoriously difficult, but the best managers are able to find opportunities, especially in troubled markets,” London-based Rick Sopher, LCH’s chairman, said in the report. Funds lost a net $123 billion, LCH estimated.

Brevan Howard

Macro hedge funds lost 7 percent last year, according to Bloomberg data.

LCH’s research on the 10 most profitable hedge funds ever shows such firms earned clients a net $3.1 billion in 2011. Other money-making hedge funds on the list included Brevan Howard Asset Management LP’s Master Fund with $3.2 billion of gains and Baupost Group LLC with $400 million. Brevan Howard, based in London, was co-founded in 2003 by former Credit Suisse AG trader Alan Howard, 48, and Seth Klarman, 54, founded Boston- based Baupost in 1983.

LCH said its analysis of how much hedge funds made for investors after charging performance and management fees is based on discussions with the funds, audited reports issued by the firms and confidential sources. The total typically includes a manager’s investment in his own firm.

Funds that lost money last year include Paulson with $9.6 billion, George Soros’ Quantum Fund with $3.8 billion, David Tepper’s Appaloosa Management LP with $800 million and Louis Bacon’s Moore Capital Management LLC with $300 million, according to LCH’s estimates.

‘An Aberration’

Paulson, who made billions of dollars betting against the U.S. housing market in 2007, remains the third-most profitable hedge fund manager ever after rivals at Bridgewater and Quantum, according to LCH.

“Our performance in 2011 was clearly unacceptable,” Paulson, 56, wrote in a letter sent this month to clients. “We took too much equity exposure and lacked sufficient hedges to mitigate the market volatility. However, we believe 2011 will be an aberration in our long-term performance.”

Caxton Associates LP and Thomas Steyer and Andrew Spokes’ San Francisco-based Farallon Capital Management LLC didn’t make or lose any client money last year in their main funds, LCH’s data show. Soros, 81, decided last year to return all money to outside investors. Bruce Kovner, 67, Caxton’s CEO and founder, retired in 2011 from the New York-based firm, which is now managed by former Goldman Sachs Group Inc. trader Andrew Law.

SAC Capital

New to LCH’s list of the most profitable hedge funds through 2011 is Steve Cohen’s SAC Capital Advisors, which has made $12.2 billion for clients since inception in 1994, according to LCH. SAC, based in Stamford, Connecticut, replaced Edward Lampert’s ESL Investments Inc. of Greenwich, Connecticut.

Below is a list of how much money clients have made investing in top hedge funds since inception. The data are provided by LCH Investments NV.

Hedge Fund                 Net Gains           Year Founded
Bridgewater Pure Alpha $35.8 Billion 1975
Quantum Endowment Fund $31.2 Billion 1973
Paulson & Co. $22.6 Billion 1994
Baupost $16 Billion 1983
Brevan Howard $15.7 Billion 2003
Appaloosa $13.7 Billion 1993
Caxton Global $13.1 Billion 1983
Moore Capital $12.7 Billion 1990
Farallon $12.2 Billion 1987
SAC $12.2 Billion 1992
Take this list with a grain of salt. I can tell you even though they're great hedge funds, the one large fund I would invest in above all of these at this point of the cycle is Ken Griffin's Citadel Advisors whose main funds have fully recovered after losing roughly 50 percent during the financial crisis, and will again be able to charge performance fees.

When a large hedge fund comes back from a beating like that, it tells me a lot. Despite getting clobbered in 2008 when liquidity dried up, they hunkered down and focused on delivering performance for their clients and recovered quickly by reading these markets carefully and taking intelligent risk (you also have to understand why they lost so much money; if you were patient enough, you made it all back).

Importantly, a great hedge fund manager knows how to come back stronger after posting losses. This is true of Ray Dalio, Ken Griffin, Louis Bacon and others. Even the best of the best have difficult years.

Right now, billions are being shoved into hedge funds. The mania has started all over again. Citing another survey, Reuters reports that hedge fund assets may hit $2.1 trillion in 2012:

Hedge fund assets under management could reach $2.13 trillion at the end of the year, as investors put more cash into the industry and managers report positive returns, a survey conducted by Credit Suisse (CSGN.VX) showed on Monday.

The survey, which covered more than 600 institutional investors representing $1.04 trillion of hedge fund assets, found that investors expect their hedge fund portfolios to return 8.6 percent in 2012, down from 11 percent last year.

This positive performance, together with new investor cash, means the sector will grow by around 12 percent from a year earlier -- adding about $200 billion worth of assets.

"Institutional investors remain positive on hedge funds and on the outlook for further industry growth. They continue to look to hedge funds to generate uncorrelated returns and to reduce overall volatility within their portfolios," Robert Leonard, managing director and global head of capital services at Credit Suisse said.

The survey also asked investors, which include pension funds and family offices, their preferred strategies for 2012.

More than a quarter of respondents said global macro funds, which make calls on global economic events with bets on bonds, currencies, commodities and equities, would be the best performers, while 19 percent selected long-short equities and 18 percent emerging markets, the survey showed.

Global macro, where the likes of industry giants Brevan Howard, Moore Capital and Tudor Investment operate, is also the most sought-after strategy for 2012.

This is ahead of computer-driven funds that bet on futures markets, known as Commodity Trading Advisors, and fixed income arbitrage strategies, which wager that tiny price dislocations in bond markets will correct themselves, and was one of the few sectors to finish last year in the black.

"One of the big bugaboos for investors was the high degree of correlation between long-short (managers) and equity benchmarks," Leonard said.

CTA and macro funds generally provide less correlation with wider equity markets.

Concerns that hedge funds, which generally charge higher fees than long-only managers, are overly correlated with each other is also the biggest risk facing the industry, the polled investors said, ahead of sovereign default risk and counterparty concerns.

Asia and emerging markets are the two most popular areas for hedge fund investments, the survey showed, while investors plan to cut their holdings in European-focused strategies as the region's debt crisis threatens more volatility.

Investors also expect a rise in the number of hedge funds that will merge or liquidate in 2012, although this will largely affect smaller managers that have failed to increase their assets to any significant size.

Despite many hedge funds performing poorly last year -- when the average fund lost close to 5 percent, according to industry tracker Hedge Fund Research -- only 5 percent of those surveyed by Credit Suisse expect funds will end the year in the red.

Global macro has always been popular but even more so now because of what is going on in Europe. It's scalable, liquid, and a handful of managers are exceptional. Having said this, I think investors will end up being disappointed with the returns of macro strategies going forward.

More worrisome, all this money 'chasing alpha' makes me very nervous. Most investors haven't the faintest idea about structuring their hedge fund portfolio and that will come back to haunt them when the next crisis hits.

Below, Ray Dalio's Pure Alpha hedge fund made $13.8 billion for its investors last year, while John Paulson lost clients almost $10 billion, according to a report by LCH Investments NV on the 10 most profitable hedge funds. Olivia Sterns reports on Bloomberg Television's "Last Word" with Andrea Catherwood.

Also, Bloomberg's Betty Liu reports on Citigroup's challenges in the hedge fund business since it bought CEO Vikram Pandit's Old Lane Partners in July 2007. She speaks on Bloomberg Television's "In The Loop." Read more about this story here.

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