Top Quotations From Battle Of The Quants

Latest four stories on Hedge Fund Insight:

Top Quotations From Battle Of The Quants London
"An edge in analysis of social media is much more feasible than in analysis of news - there are only six traders globally who are successful trading off news analysis, " Rob Passarella, DataSift.

"There is a huge leap to move from getting  interesting signals to a viable investment strategy," Leigh Drogen, Estimize. Read more >>


SEB Bias Towards RV and Macro In Outlook For Hedge Funds
The market is being driven mainly by investor risk appetite and sentiment, which in turn are driven by unpredictable political decisions. Central bank actions are also driving hedge fund returns to a growing extent, as are hopes for a new round of quantitative easing from the US Federal Reserve (the Fed) or the European Central Bank (ECB)’s potential purchases of government securities from peripheral euro zone countries. Read more >>


SVM Positioned For US Recovery To Beat Expectations
SVM portfolios are currently fully invested, recognising attractive valuations in the UK and Europe and a more encouraging outlook for global growth.  In the US, news in construction, housing and retail suggests that the worst is past. US construction and housing sectors, representing in total one-sixth of the US economy, are steadily recovering.  We believe that US recovery will beat expectations.  US banks are also much better capitalised than UK and European ones, and have largely gone through their write-offs.
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Hedge Funds’ Performance? Volenti Non Fit Injuria
The rules on investor eligibility mean hedge fund investing “is not by any enterprised nor taken in hand unadvisedly or lightly; but reverently, discreetly, advisedly, soberly and in the fear of God, duly considering the causes for which alternatives are ordained”. The hedge fund industry has no case to answer against the recurring charges of non-performance and self-enrichment at the expense of clients. Those who invest in hedge funds willingly undertake the investment and operational risks implicit in the niche money-making schemes of the stinking rich. All of the usual criticisms, e.g. the fees, the hidden beta, the lock-ups, the illiquid holdings and the spraying of chic joints’ walls with Tattinger, are all disclosed in the offering documents and/or are writ large in the industry’s track record, which is getting on for thirty years as an investment style.
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And How Have The Internal Processes Developed At The Endowment To Invest In Hedge Funds?

One of the best things about the flows into the hedge fund industry coming from American investing institutions is that a good proportion of them are from public bodies. Consequently there is very good transparency about the activities in the hedge fund sector of state pension plans, for example.

Through the annual NACUBO study it is feasible to track quantitative information such as allocations to and returns from hedge funds in aggregate across American college endowments.  There can sometimes be good qualitative information about the hedge fund investment programs of college endowments because of the requirement to be publicly accountable. So it is that we can get an insight into the Absolute Return Strategies process at the endowment of the University of California - through the availability of Board papers from the Regents Office.

For a Board Meeting in February this year the hedge fund consultants to the Regents, Albourne Partners, were asked to prepare a memo giving their view of the Manager Selection processes employed in the construction of the UC Absolute Return portfolio, and the competence of the UC Absolute Return Investment Staff. What follows is a lightly edited version of the memo.

The Memo to the Board shows how the investment process for investing in hedge funds evolves at an investing institution. It also gives a real world example of the impact of constraints put on an investment mandate. The limitations of manager size and desired liquidity (ability to deal in the funds) are cited.  The Memo reflects the move away from large multi-strategy managers to try to allocate to emerging managers. And manager fees have been negotiated.

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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.

Additional:

(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.

Out of the Box - Graphic of the Day – Why Hedge Funds Will Continue to Grow

One of the advantages of looking at the activities of institutional investors is that their behaviour follows decision-making which stands for years at a time. The Investment Committee of a pension plan changes the strategic asset allocation say every 5 or more years. There may be a decision made to have 25% of plan assets in domestic equities with a tactical band of 20-30%, which allows for variation on an annual basis away from the central tendency of 25%. But for most of the time over six or seven years the plan assets will be around 25% in domestic equities from that point onwards, after a period of implementation.

The implementation of the change in asset mix will often take place over a year or more as mandates are changed, contractual notice is given to the money managers with the mandates, and the underlying assets are bought and sold. Allocations to domestic equity have tended to shrink over recent years, so the process might involve a plan sponsor giving six month notice to a Trust Bank that their mandate will halve in size, and then, in six months time the bank will liquidate a portion of their large cap mutual fund and transfer the cash to the pension plan's administrators.

The reverse process is expected to happen for hedge fund allocations over the next few years if the survey of investment consultants by Casey Quirk and eVestment Alliance is to be believed. The survey*, conducted in Dec 2010 and January 2011, asked investment consultants to forecast investment preferences and buying behaviour among North American institutional investors during 2011. One of the key trends that Casey Quirk identified was "The increasing role of heretofore "alternative" investments—hedge funds, private equity and real estate—which are emerging as the centerpiece of active asset management moving forward."

This trend in the use of alternatives reflect the new frameworks with which institutional investors and their consultants are building portfolios, with exposure defined less by product packaging or home bias, and more by the specific contributions investments make toward overall objectives. The framework is part of the new emerging paradigm for asset allocation amongst investing institutions in North America, shown in the Graphic of the Day below, and which will reinforce hedge fund growth.



Graphic of the Day  - Hedge Funds Break out of The Box
The Emerging Institutional Investment Framework

Source: Casey Quirk (Note Not to Scale)

The key point in this is that the way institutional investors see how they can use hedge funds is changing. It was hedge funds as part of an alternatives category - in a segmented ghetto by risk/return. This is changing towards hedge funds as sources of alpha within broader asset categories.  Hedge funds are breaking out of the box!

Putting this framework, and the consequent asset shifts, into practise over coming years will not benefit all asset management businesses. Amongst the attributes of the winning asset management firms, according to Casey Quirk and eVestment Alliance, will be

• Managers offering non-correlated investments.
  
• Firms offering both "traditional" and "alternative" investments will stand the best chance of providing institutional clients with a total portfolio solution.
  
• Product development and innovation will remain critical competitive differentiators.
  

The survey collators go on to turn their gathered insights into a product opportunity map – showing where demand for product will be strongest.



2011 Product Opportunity Map

Source: Casey Quirk, eVestment Alliance

It is important to understand that the product opportunity map compares expected search activity for the upcoming year relative to forecast from the previous year. What is clear is that consultants continue to believe that longer-term trends in search activity favour hedge funds, funds of hedge funds, and non-U.S. equities. However, there is a perceived shift in the demand for funds of hedge funds:

"Consultants focused on larger investors, as well as those focused on non-profit funds, expect more searches for direct investments in hedge funds than they did in 2010. This reflects three realities.

• First, most North American institutional investors selected a core fund of hedge funds in recent years, and few are yet convinced they need a change.
  
• Second, and more importantly, larger investors now seek more specialized FOHF strategies in place of, or in addition to, a diversified FOHF mandate. This challenges many FOHF vendors who do not offer a focused product.
  
• Finally, larger institutional investors—particularly well-funded non-profit funds—still seek to avoid higher fees and pooled vehicles offered by FOHFs.
  

FOHFs remain core investment vehicles among smaller pension plans who lack resources to select or access direct hedge fund investments. Additionally, investors increasingly are using outsourcing firms to provide exposure to a portfolio of hedge funds."

 
The trends identified by the survey authors will likely persist for some years, as allocations in pension plans change slowly, and allocations to hedge funds are going up – doubling in some forecasts. So hedge fund capital flows should be positive at the industry level on a multi-year outlook. There is still a role for funds of hedge funds serving American institutions, and indeed there should be growth in assets this year and next for funds of hedge funds as a whole. But to benefit from those allocations funds of hedge fund businesses are going to have to be in the top quintile of performance ranking over 5 years, and in 2008 specifically, or have a very good specialised product (by geography or investment strategy) to offer.





*This year, 55 investment consultants, representing an aggregate $10.4 trillion of assets under advisement participated in the survey.

Syz’s Altin Zigs When Others Zag

ALTIN AG (LSE:AIA) (SWX:ALTN), the Swiss alternative investment company listed on the London and Swiss stock exchanges, discloses quarterly its entire hedge fund portfolio holdings as part of its policy of full transparency to investors initiated in 2009. Looking at the strategy allocation shifts of the fund of funds managed by Banque Syz makes an interesting contrast with the expressed biases of investors in hedge funds given in the Deutsche Bank Alternative Investment Survey.


Graphic 1. Net Allocation Plans by Strategy of Hedge Fund Investors

Source: 2011 Deutsche Bank Alternative Investment Survey

Asked in January this year, the respondents to the survey ranked as the top three strategies for receiving allocations of capital in 2011 as equity long/short, event driven and global macro. So it was striking that the Alternative Asset Advisors SA, the subsidiary of Syz that manages ALTIN AG, had acted in exactly the opposite way over the first three months of the year. As the fourth column in graphic 2 shows the largest reductions in strategy allocations made by 3A were in equity long/short, event driven and global macro.

Sometimes reductions in allocations in portfolios of hedge funds are effected through a passive route. That is as flows come in, net new subscriptions are allocated to preferred strategies, and the strategies or managers with sufficient allocations at that point are diluted. But ALTIN is a closed-ended investment company, so the capital available to invest changes with new capital raisings on the stock exchange and with leverage. There have been no capital raising (in fact shares in ALTIN AG have been bought back), and leverage at the portfolio level is broadly the same over the first three months of the year. So in this case the reductions in allocations to strategy are active decisions based on a number of possible factors. The factors are views on prospective returns at the strategy or individual hedge fund level, and (fund of funds) portfolio composition issues. That is reductions may be driven by bottom-up factors (marginally high allocations to a single fund that needs to be trimmed after very strong performance or changes at the firm), or driven at the highest level of management (portfolio level leverage as a function of hedge fund returns across all strategies), as well as at the intermediate level of strategy allocation. In this case the changes seem to have been made at the intermediate level because two funds have been added that invest using investment strategies that were not represented in the portfolio at year end.


Graphic 2. Breakdown of Capital by Investment Strategy of ALTIN AG

Source: Regulatory News Service of the London Stock Exchange

The two new funds are ZLP Offshore Utility Fund Ltd (an equity market-neutral fund) and Providence MBS Offshore Fund Ltd (a fund investing in mortgage backed securities (MBS), under Fixed Interest Strategy in table above). The first of the new funds is a sector specialist fund that adds value by the application of deep knowledge of one industry. The market-neutral fund, managed by Zimmer Lucas Capital of New York, should produce a return stream with a low correlation with traded markets. The managers of ALTIN know the managers of the fund very well – 3A were early backers of Zimmer Lucas Capital as far back as the year 2000.

The Providence MBS Offshore Fund Ltd is managed by Russell Jeffrey, founder of Providence Investment Management LLC of Providence RI. The $895m fund takes a relative value approach to residential MBS, and capitalizes on price dislocations in the agency MBS and related fixed income markets. The fund has a CAGR of 23.44 % since inception in 2004, and over the last 3 years it is ranked in the top 0.1% of all hedge funds for absolute returns.

The Deutsche Bank survey of investors in hedge funds showed no net interest in investing in either equity market-neutral or dedicated fixed income strategies in 2011. So it is not just in reductions in allocation to strategies that the managers of ALTIN zig when others zag, but also in new subscriptions to hedge fund investment strategies.