Wednesday, 26 October 2011

Macro Managers Coming Through at Last

One of the disappoinments this year has been the performance of global macro managers. At the stage of half way through the year, it seemed that if a manager in this strategy had ridden the wave of QE2 inspired up-moves in equities and commodities then they gave it back by staying too long at the party, as the effects of monetary stimulus dissipated in May and from that month onwards. Those that lost a little in the 1Q may have made a bit back by mid-year, but there seemed to be too few managers that were able to ride markets in one direction and then the other with enough conviction or timing to make money across the whole of their books.

The pattern seemed to be if you made money early in the year you gave it back later. If a manager had a positive P&L in equities, they lost enough money in FX to be left around flat for the year. To be fair to the macro managers the market action this year, whether in fx or commodities or equities, has oftentimes not been in a pronounced trend for long. So it is that CTAs, the ultimate feeders off markets exhibiting trending behaviour, did not make good money until the last few months. Further, reversals have been sharp and volatility high - which makes it hard to hold onto gains even when they have been chiselled out of recalcitrant markets. The exceptions to the generality amongst global macro traders were those that tend to specialise in fixed income - the likes of Brevan Howard - for whom the trend was their friend for long enough for decent gains to be made by end of July.  

One of things that surprised me at the half way stage in the year was that so few macro managers had made much at all. Some of these big-picture managers tend to have core fixed income books, and others express their views on Chinese growth in the fx markets or in commodities. But they all may be positioned long or short, and they decide their own timing and sizing. So there is a lot of scope for the universe of macro managers to have completely different directional bets in the same market. Those that don't do much in energy, might concentrate on time spreads in softs or run a big book in credit trading. The point is they need not have correlated returns at all - in fact logically the universe of global macro managers should always have the biggest dispersion of returns amongst hedge fund strategy groups, and most of the time it does. By happenstance, taking all these different views and putting on unrelated trades across a wide selection of markets, hardly any macro managers had made good returns by the end of June this year. However the market gyrations of August and September have allowed a different story to be told for the period since.

Only this week Luke Ellis of Man Group was commenting that there was a very wide dispersion of manager returns amongst hedge funds in August. In September there was an historic extreme of dispersion of returns amongst managers running hedge funds. So for observers of, or investors in, hedge funds the returns of August and September become much more about which managers you were in, rather than which strategies you were allocated to. And practically it means that index or industry level returns for hedge funds for those two months start to be quite unrepresentative. We are well used to seeing headlines about "Hedge funds failing to deliver this month/on the year to date" based on index level returns, and sometimes (more usefully in this context) about returns across a hedge fund database being "good" or "bad" or generally different from returns on the underlying markets at an asset class level.

When the YTD numbers are close to zero, the next data point has a big impact on YTD returns. That is what has happened to hedge fund returns this year, and for some global macro funds in particular. The tables shown here are from "Absolute Return" magazine  and pick out amongst US-based managers the best returns produced last month. It is pleasing to see the marked presence of macro managers at the top of the rankings after the year they have had.  

These are good returns of specific managers in the global macro investment strategy. However, today I see that The Greenwich Investable Hedge Fund Indices give the index level returns for macro managers as -0.79% for September and -3.72% for the year so far. My experience of dealing with investors in hedge funds is that they are looking at what their specific hedge fund managers have done for them. There will be nearly no one who has experienced a return from their macro managers of -3.72% in the year to date (for reasons of position sizing and the timing of subscriptions and redemptions, if nothing else). Given the extreme dispersion of returns in September, and that macro managers have the widest dispersion of returns amongst any hedge fund investment strategy I can confidently say that no-one except an index investor has actually got a return of -0.79% from their macro managers last month. The inference is that the returns of the last two months will tell investors a lot about the quality of manager selection amongst their advisors and consultants, and amongst funds of funds. And not just in global macro.

(Dec 7th 2011) Reuters posted an article headed "Global macro hedge fund returns fail to impress". The full article is posted here. The article mentions Louis Bacon's Moore Global Investments, Fortress Investment Group, Tudor Investment Corporation, Caxton Associates and Brevan Howard.

Monday, 10 October 2011

Risk Managers are the Social Workers of Asset Management?

Recent research has shown that in the UK 86% of youth workers/social workers time is spent in completing forms for reporting, and in attending meetings about clients and how the services are run. Only 14% of time is spent with clients. 

This skewed sense of priorities came to mind when I read the 2011 Risk Management for Asset Management survey from Ernst & Young. In the survey there is a section about how risk managers in asset management companies use their time. The collated responses are in figure 1.

Figure 1. Relative priorities for risk management in terms of time

Source: Risk Management for Asset Management Ernst & Young Survey 2011 (page 35)

If this survey reflects the reality of how risk managers are spending their time risk monitoring takes up 10.8% and risk reporting takes up 9.7% of risk managers' time. I would like to think that the label "general risk management and client contact" applies to time spent with portfolio managers and analysts, but it is more likely to be with the Head of Equities or Chief Investment Officer, or in some client meetings.

Rather like IT spend in an asset management business, it seems that most of the budget (budget of the time in this case) is on the hygiene factors - the necessary operational systems (activities). At the moment there is lot of hygiene stuff to take care of in risk management in asset management businesses -  tax related issues, KIIDs, increased burden of regulatory reporting and compliance, liquidity issues and not least counterparty issues.

But where is the main event at the moment? Is it not in the markets  - the challenges to the business models of asset management businesses, real time stress tests of portfolio managers and their approaches to markets, the very viability of the financial sector in Europe?

What are risk managers spending time on?: regulatory affairs and contacts with regulators are taking up twice as much time as risk monitoring; country risk assessment is taking up less time than fraud risk.

In an inversion of the prevailing norm in social work, in a project in Swindon that works with chaotic families 60% of the budget is now going on selected face-to face service provision. This puts a bigger priority on the work that is the raison d'etre of the service, rather than its reporting processes and management.
A good risk manager can be a very positive influence on keeping the assets under management. The risk management function should help avoid blow-ups and gap risk, and assist finding useful hedges at the company level as well as the portfolio level. Good risk management is a long way from being just a quasi-compliance officer with a numerate degree. But the priorities and resources have to be agreed and in place for a fully realised risk management function to work as it can. Asset management companies should do a Swindon.

Wednesday, 5 October 2011

The Dangers of Mixing the Functions in a Hedge Fund Management Company

In an in-depth due diligence questionnaire of a hedge fund manager there is often a question about the outside business interests of the principals. For an organisation with a broad team of decision makers managing investments this is less of a concern. To the extent that there is a single presiding talent who sets the tone and manages the largest allocation of capital, it is an issue if an individual has executive duties in other companies, or has too many non-executive directorships or Board positions. Think of SAC - if Steve Cohen more actively pursued his art interests at the expense of time at the firm would that that impact the returns produced by the whole firm? Undoubtedly, yes. But there are other ways in which hedge fund investment managers can be distracted from their main event.

I was reading about companies' management structure (link here, with thanks to author Daniel Dupree), perhaps a hangover from my Business Studies degree, and  was reflecting on how the construct applied to the hedge fund business. The article was about levels of management:

Management levels within an organization exist to demarcate different roles within the organization or company, and to help establish a chain of command. Broadly, there are three main levels of management. You can think of the levels as a triangle, or pyramid. At the top level, there are fewer people, but they have more say in the overall direction of the company — they have more authority. This level is often called the administrative level. At the second level of management, you have those who have some authority over certain departments or projects. This is called the executory level, since those who populate it are involved in executing so that the aims of the organization are met. Finally, at the bottom of the pyramid, is the supervisory level. These are managers that have more direct contact with workers, and are mainly involved in encouraging performance, and monitoring employees. 

The article then goes on to describe the scope of work in each level. Here are the descriptions of the top two levels:

Top Level: Administrative

The top level of management in most organizations is the ultimate authority. Administrative level managers can give authority to other managers in the organization, delegating to, or directly promoting, other managers. The top level of management consists of board of directors, top officers in the company, and directors in the company. Some of the functions of those at the top level of management include:
  • Setting out the goals, benchmarks and big picture for the organization.
  • Prepares policies for the organization, and sets forth consequences for their violation.
  • Promotes and appoints others to fulfill various roles in the company.
  • Coordinates activities for the whole organization, making sure that different departments are working in tandem to reach the organization’s goals.
  • Usually in charge of making public statements on behalf of the organization, as well as making appearances so that the community is aware of what the company is doing.
  • Directs broad changes in company direction.
  • Shows accountability to shareholders and other stakeholders in the company.
  • Ultimately responsible for the success or failure of the organization and its enterprises.
Those in the top level of management are often well-compensated for their efforts, due to the fact that, in theory, they have great responsibilities. It can be difficult to make it to the top level of management, since those positions are often scarce, and the competition for them is fierce. However, with hard work, good ideas, competence, and an ability to network, it is possible to reach the top level of management.


Middle Level: Executory

Depending on the size of the company or organization, middle management can be bigger or smaller. In some of the smaller organizations, the functions of the middle level and lower level of management are combined. However, in larger organizations, middle level management often requires additional divisions into senior and junior levels.
At this level, managers are in charge of branches or departments. Their job is to come up with sub-plans that contribute to the success of the company when meeting its goals. Middle managers are often involved in making sure that the steps to achieving the larger aims of the company are carried out. Some of the other duties that those at the executory level of management might be required to carry out include:
  • Training lower management, and training employees.
  • Coming up with incentives for employees and lower level managers.
  • Coordinating projects within the departments and branches.
  • Evaluating employee and lower manager performance.
  • At more senior positions in middle management, sometimes it is necessary to interact with the public, or issue statements.
  • Report to members of the top level of management. This might include in-person reports, or written reports and memos.
  • Enforce policies handed down from top management, and sometimes discipline lower level managers, or employees.
The owners of hedge fund businesses carry out all the tasks of Top Level Management as given above. However, it is quite usual for the largest shareholders of a hedge fund business to be carrying out the main activity of the company, that of carrying out research and making investment decisions. That is, the principals of a hedge fund management company carry out the Executory Level activity as well as fulfill the roles of those in the Administrative Level. Even where there is a separate CEO in a hedge fund, the CIO whose name is over the door is highly likely to be involved in decision-making related to how the business is run as well as how the investments are run.

Switching Modes

For many senior figures running portfolios this involves looking at a trading screen and taking company and investor meetings until the end of the trading day, and then switching modes to take Executive Committee meetings and Board Meetings into the early evening. If there are not those formal meetings there will be job interviews and looking through (management information system) reports on the business after the Bloomberg screen has gone dark.

I had a reminder of the duality of the lives of the senior executives running hedge fund companies when I bumped into one of them off Davies Street in Mayfair yesterday. In the course of  our exchange he disclosed that the meetings and reading of documents associated with the expansion of his business was taking up some of his normal trading screen time. He said "I've cut back on the number of markets I'm actively tracking, and, to be honest, even in those I'm relying on what I researched earlier this year for the core of my views."

This chimed with what I had read about events at Touradji Capital Management this year. Paul Touradji is the former head of commodities trading at Tiger Management who set up his own firm in 2005. Just over two years later Touradji Capital was running $3.5bn in commodity related funds. But the progress of the firm has not been smooth since the Credit Crunch.

Returns from the funds were disappointing in the last two calendar years - up 4.5% in 2009 and then up 2% in 2010 against a background of bull market conditions in commodities. Investor redemptions took capital down to below $2bn this year. The senior management team has not been stable. Gil Caffrey came on board from FrontPoint Partners to be CEO at Touradji Capital Management, only to decide last year to walk across the hall back to Tiger Management. Julian Robertson's Tiger Management shares office space with Touradji Capital on Park Avenue, New York. Sang Lee was brought in as President of Touradji Capital in October 2010 as part of a handover of day-to-day management of the firm from Caffrey. But that transition was not successful.

It was announced last month that President and Chief Operating Officer Sang Lee and CFO Tom Dwan will leave the firm, and a search is on for high calibre replacements. In a letter to his investors Paul Touradji wrote "Simply put, the daily operation of the firm must go from being a major time and energy drain on me to an integral support function for our entire team, allowing us to concentrate our full attention on investment performance." The flagship fund of Touradji Capital Management was down 17% in the first 8 months of the year.

Touradji Capital Management is not a start up or a very small hedge fund management company. But events there illustrate that non-investment issues can be a drain on the capabilities of professional investment staff at the very top level of hedge fund companies. Even very capable people have to be careful about how they allocated their time and intellectual bandwidth. To consume the creative thinking time of a well-paid investment professional at the top of his game with the banalities of failed trades and who is doing the cash reconciliations this week is a failure of management resource and structure.

Potential investors in hedge funds sometimes go to great lengths in due diligence to fully appreciate the state of play at a hedge fund management company. I heard a comment this week that there is something of an arms race in due diligence processes amongst funds of hedge fund companies, as they try to differentiate themselves on something other than results. But there is a risk in a small company that the scarce resource of management time can move from the mission critical (investing) to the necessary (operations and company oversight) and that is something of which a prudent investor should be aware.