Monday, January 12, 2015

Another Big Blow to Hedge Funds?

Miles Johnson of the Financial Times reports, Dutch pension scheme pulls €4bn hedge funds investment:
Europe’s second-largest public pension fund has withdrawn all of its €4.2bn investment in hedge funds, and issued a damning indictment of their performance, fees and “often limited concern for society and the environment”.

In a new blow to the hedge fund industry, the €156bn Dutch healthcare workers’ pension fund — known as Pensioenfonds Zorg en Welzijn (PFZW) — said that it had “all but eradicated” its hedge fund holdings because of its disappointment in their investment performance, cost and complexity.

PFZW’s decision makes it the latest large institutional investor to decide it could no longer justify hedge funds’ fees and opacity after several years of poor investment performance. Calpers, the largest public pension fund in the US, said last year it was pulling out of hedge funds, arguing they were too complex and costly.

PFZW said on Friday it had invested in hedge funds in order to add diversification to its investment portfolio, but had now decided its hedge fund holdings — which represented 2.7 per cent of its €156bn of assets in 2013 — no longer met its investment policy.

“For a long time, hedge funds were a useful tool in this regard, but lately they have not made a sufficient contribution to this objective,” the pension fund said.

It also cited what it termed “the sustainability factor” of the industry.

“PFZW concluded that hedge funds are no longer a good fit for the portfolio, given the high remuneration in the hedge fund sector and the often limited concern for society and the environment.”

Large public sector pension funds have provided an increasing proportion of hedge funds’ assets under management over the past decade, increasing the public scrutiny of a traditionally secretive industry.

Pensions account for 36 per cent of the $3.1tn of assets invested in hedge funds globally, according to Towers Watson, a consultant.

But in recent years, many of the world’s largest hedge funds have struggled to generate meaningful returns for their investors at a time when the value of many traditional investments has surged.

Last year, only 22 hedge funds in the world managed to beat the near 14 per cent return of the US S&P 500, according to hedge fund performance data compiled by Bloomberg.

From 2008 to 2013, the average hedge fund managed to generate returns after fees of only 3.6 per cent each year, according to HFR, significantly less than a simple collection of stocks and bonds over the same period.

At the same time, hedge fund managers’ pay has surged, with the world’s 25 best-paid hedge fund managers gaining an estimated $21.1bn in 2013 — equivalent to the entire economy of Jamaica.
In what is the latest blow to the industry, another major pension fund followed CalPERS and fully exited out of hedge funds. And we're talking big money here, not chump change (CIO reports the heads of these hedge fund programs are now looking for new employment).

But fret not my little overpaid hedge fund minions, there is plenty of dumb pension money out there looking to hobnob with the "power elite" of the alpha industry, chasing returns at all cost, desperately looking to achieve their rate-of-return fantasy. Most of these public pension funds will get burned chasing the hottest hedge funds, but it's all good, they're not investing their money, so they don't really care.

I know, I sound like such a jerk but the truth is most hedge funds stink, charging alpha fees for leveraged beta or sub-beta performance. Moreover, most institutions are ill-equipped to invest properly in hedge funds and end up relying on useless investment consultants that shove them in the big brand name funds with little or no regard to how well they're performing or going to perform in the future.

No doubt about it, there are plenty of great hedge funds out there. I just finished covering the best and worst hedge funds of 2014, going over many funds that did well last year. I also cover the equity portfolio moves of many top funds every quarter.

But the grim reality remains that far too many institutions are getting absolutely raped on fees investing in hedge funds and all they're really doing is feeding the industry's oversized egos. They don't have the proper team in place to carefully evaluate the performance, risks and process of these funds. And many of them are just following the herd thinking (hoping) they know what they're doing but they will get clobbered when the next financial crisis hits.

I'm going to be brutally honest with many pension funds reading my blog. A lot of you should follow CalPERS and PFZW and get out of hedge funds while you still can. In fact, many of you should also get out of private equity and real estate too. You're ill-equipped to understand the risks of these alternative investments and you're going to be doling out huge fees for huge under-performance relative to a balanced portfolio of stocks and bonds.

One astute hedge fund investor shared these comments with me:
Would you agree that the real #1 reason for an institutional investor to invest in hedge fund strategies should be based on the opportunity cost of capital?

Basically, if someone can leverage its balance sheet a little, the cost of capital is the risk free rate. Its quite different if someone can't leverage because in such cases, the cost of capital is the expected return of the balanced portfolio. If you cannot lever up, hedge funds cannot compete on an after fees basis. But that's an operational model issue. Considerations about fees, sustainability and scalability fall far behind the opportunity cost of capital consideration.

But when you can leverage and ask yourself which investment strategy makes the most sense to leverage, aren't hedge fund strategies (the alpha oriented ones of course) the only ones you can logically can if you are working with a more or less fixed risk budget (on the grounds that if you carefully select your hedge fund strategies, they won't consume incremental risk yet enhance returns)?

As long as you have a positive net expected return that is not correlated with anything else and 0-beta, and if you own the process (not outsourced to a consultant as you rightfully point out) why would you not consider investing in hedge fund strategies, even if that expected return is 3-5% per year?

Seriously where can I find an investment strategy that produce higher units of alpha per unit of beta?
To which I replied: "I would agree with your cost of capital argument and completely agree that leverage figures prominently into the decision to invest in hedge funds and other alternatives but it doesn't negate my observations that most hedge funds stink and most institutions shouldn't be investing in them because they're ill-equipped to understand the risks and forward prospects of hedge funds' performance."

Perhaps the biggest problem with the entire hedge fund industry is there's too much testosterone (and steroids) and not enough estrogen and brains. Lawrence Delevingne of CNBC reports, Meet the most powerful woman in hedge funds:
The hedge fund industry has two new massive independent money managers to start 2015.

Leda Braga formally started Systematica Investments this month after years under prominent European hedge fund firm BlueCrest Capital Management. Geneva-based Braga manages the same amount she ran at BlueCrest, $8.5 billion, easily making her the most powerful female hedge fund manager in the world in charge of her own shop.

David Warren also completed his transition out of Brevan Howard Asset Management, another European hedge fund giant. Warren's newly independent firm, New York-based DW Partners, starts with more than $6 billion in assets.

As stand-alone firms, Systematica and DW instantly rank among the top 100 hedge fund managers by assets. By comparison, Bill Ackman's Pershing Square Capital Management runs $18.3 billion, Dan Loeb's Third Point manages $16.5 billion and Larry Robbins' Glenview Capital Management controlled about $10 billion as of late last year.

Braga, 48, has quickly risen to elite status in the hedge fund world.

Brazilian by birth, Braga got a Ph.D. in engineering from Imperial College London, where she also lectured. She then worked at JPMorgan Chase as a quantitative analyst on the derivatives research team, according to firm materials. At JPMorgan, Braga was a colleague of Michael Platt, who founded BlueCrest in 2000. After a stint at JPMorgan spinoff Cygnifi Derivatives Services, Braga joined BlueCrest in 2001.

In 2004, she launched and managed what became one of the firm's largest strategies and funds, BlueTrend. The fund uses a "managed futures" strategy, meaning it trades the futures contracts of stocks, bonds, currencies and commodities and looks for trends in the movements of their prices, so-called trend following.

The now-$7.9 billion strategy gained an average of 11.2 percent net of fees each year from 2004 through 2014, according to performance figures obtained by, and only lost money in 2013 (down 11.5 percent). The Absolute Return Managed Futures Index, which tracks similar hedge funds, gained 4.91 percent over the same 10-year period.

A spokesman for Braga declined to comment for this story. But her former boss Platt said it was simply time for Braga to leave given the rise of BlueTrend.

"We both feel that now is an opportune time for that substantial and distinct business to stand separately in order to enhance and develop its focus on delivering systematic and technology-driven investment solutions to a broadening range of clients across the globe," Platt said in a statement in September 2014 announcing the future spinoff.

BlueCrest retains an undisclosed stake in Systematica, which has about 100 employees in New Jersey, Geneva, New York, London and Singapore.

Hamlin Lovell, a contributing editor of The Hedge Fund Journal who researched the 2013 report "50 Leading Women in Hedge Funds," said Braga's rise to be the most powerful woman in the hedge fund industry shows that there's no limit to what women can achieve in it.

"It's still unusual to have a woman at the helm on the investment side but Braga sets a great example for aspirant quants," Lovell said, referring to Braga's quantitative investment style.
Good for her! The finance industry in general, and hedge fund industry in particular, need more successful women at the helm. Braga isn't the only female hedge fund manager but she's definitely one of the most powerful.

By the way, I just read a wonderful story over the weekend about how great things happened to a young Greek lady who was googled by Google. Women are slowly but surely making huge inroads in traditionally male dominated industries and thriving. There is a lot more work ahead as many public and private organizations aren't hiring enough women at all levels, but the shift is positive and I think more women should be recognized for their outstanding contributions.

Below, Bloomberg's Simone Foxman takes a look at the best-performing hedge funds of 2014. She speaks with Bloomberg's Julie Hyman on "Street Smart." She discusses trends in healthcare and mentions a top-performing biotech fund you probably never heard of.

No comments:

Post a Comment