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There's a place for alternatives in the post-crash era, our correspondent writes, especially when 60/40 portfolios are not a universal panacea
May 20, 2016 — 5:51 PM UTC by Paul Damon
Brooke’s Note: We found it odd that Mercer was sending out press releases in defense of hedge funds. But a number of people disagreed with us and said that Mercer is right, as professional vetters of hedge fund managers, to point out that the media’s harping of late regarding hedge fund stumbles wasn’t in full context. Most eloquent among our critics was Paul Damon and his letter is published here. But even today such a critical article appeared in Business Insider that again underscored hedge fund underperformance. Hedge fund managers get paid obscene amounts to perform and if they don’t, the media is going to take a hard look at them, and their loudest defenders.
To the Editor:
I don’t understand the premise for Irwin Stein’s 05.18.16 article (What’s up with Mercer blaming 'political pressure,’ bad press and even investor bad timing for hedge fund ills), nor whether it is intended as news or an opinion piece.
How is it odd for an institutional investment consultant to be supportive of the thoughtful usage of hedge funds in (institutional) client portfolios? It’s their business to take a longer-term view with regards to asset allocation and be experts at manager selection, diligence, monitoring and placement recommendations (hiring and firing when necessary), as it is for many other firms in the space, including Cliffwater. Should they suddenly decide to exit that business, fire associated staff and cease recommending any allocation to strategies that can help better the risk-return profile of an institutional portfolio with a very long/infinite investment horizon? The larger the universe of managers, the more relevant such investment consultants — who have done quite well taking market share from hedge fund of funds in recent years — are. Increasing correlations of broad hedge fund benchmarks that are exposed to the bloating of the industry at times and survivorship bias at others to equities don’t tell the story of individual investors’ experiences.
If hedge funds were the disaster that they are reported to be, the asset retreat would be a lot more rapid than it has been. Maybe that is coming, but even as swollen as the industry is, and as undeserving of a rich compensation structure (which is no longer 2/20, according to recent reports), as many managers are, I doubt global assets in hedge funds will dip below $2 trillion anytime soon. Big institutional managers with increasingly diversified businesses — like AQR, Bridgewater and Citadel — and deserving emerging managers should continue to win flows while less talented funds that expose investors to unwelcome volatility and/or losses will likely see outflows and close. See: How the Winklevoss twins disrupted a big NYC hedgie event and distracted from the poor job most hedge funds are doing for clients.
Investing in a 60/40 portfolio, as tempting as that may be given how good both asset indexes have done post-crisis, won’t leave you without potentially deep losses in certain environments, especially considering market distortions due to central bank liquidity (which, yes, has made fools of many an active manager); it’s just not that easy. That’s where allocating some percentage (e.g. 5%-20% perhaps, depending on objectives and risk tolerance) to risk-dampening strategies can provide value. See: The truth about hedge fund risk.
As such, I’d advise more balance and consideration in your reporting on alternatives, which seems to be lacking of late. My thinking goes back to the Blackstone/ Fidelity article RIABiz published Friday, April 8 (Fidelity dumps two liquid alts managers after they fail to deliver the vaunted “hedge effect” in stormy markets), which featured performance figures for Blackstone Alternative Multi-Manager Fund (BXMMX) that didn’t exactly check out and failed altogether to mention that fund is/was actually a category leader since inception in the Morningstar multialternatives category. This hedge-fund-of-funds-like category the fund belonged to wasn’t mentioned in the piece, rather it was simply lumped in with all of liquid alternatives, a swiftly growing pool of varying strategies.
It also failed to mention that the Blackstone registered (40 Act) fund platform has two products, with “identical” objectives (see Blackstone’s words from its press release announcing the closure), and fees. The other fund, Blackstone Alternative Multi-Strategy Fund (BXMIX), launched 10 months after the liquidated Fidelity-seeded BXMMX (giving it about one-third less time, or about 22 months then, to gather assets), managed to accumulate $4.3 billion in assets (as of the article’s 4.08.16 publishing). That amount is multiples of the $1.2 billion in BXMMX prior to the redemptions started in February, as reported by Bloomberg. That’s certainly impressive but, after all, this is the world’s largest discretionary investor in hedge funds, so I guess we shouldn’t be too surprised of this pull to the registered offering.
Exceptions not noted
Maybe the decision on Fidelity’s part, which it was rather vague in explaining, wasn’t as centered on performance as the article suggested. If it was, it was a shortsighted decision (i.e., based on relatively deep losses YTD through March, not the since inception performance, which was better than the majority of its peers in the liquid and HFoF space, including managing risk very well in the latter half of 2015), exactly the type of myopic action which asset managers tell advisors and advisors tell clients to be mindful of.
And that should’ve been pointed out in an article that allowed such space for speculation as to the termination. But I don’t know the reason. Maybe Fidelity PAS just wanted to utilize a different strategy in their (quite small) alternatives allocation that potentially achieved even greater diversification or one that they felt was more scalable. Whatever the reason, I think it is important to evaluate these instances carefully, being mindful of how much any given fund in the news may or may not represent themes in the overall alternatives industry.
Further, politics, whether local or national, is always a very important consideration with public pensions and has been known to influence decisions. That’s no surprise; that’s part of the process of transparency and disclosure that goes along with the public plan space. It can push fees down and force accountability just as well as it can unfortunately lead to exiting investments at the wrong time, locking in losses on top of high fees. See: The hedge fund legal elite meet in NYC to wrestle with a terrifying new threat — RIA-like accountability.
But what about the case of San Francisco Employees’ Retirement System (SFERS), which in February 2015 despite public protests, decided to allocate 5% of their then $20 billion portfolio to hedge funds after a protracted debate where critics drew from CalPERS’ decision (which was more about challenges achieving scale frankly)? Or what about the California State Teachers’ Retirement System (CalSTRS) recent 9% “risk mitigation strategies” allocation to alternatives, including hedge funds and hedge fund-like strategies? Are those instances not worth mentioning alongside the hedge paring?
And what about comment from the voices in the more retail space — like “CAIS”, Dynasty, HedgeCoVest, etc. — that could provide insight more focused on the wealth management challenges of alts usage and client education? None of the firms mentioned here are my clients nor do I represent any hedge fund managers or hedge fund industry trade bodies currently. See: Now come the robo-alts firms — a full flock of 'em as unwavering as the robo-advisors.
I see the note at the end of this Mercer article that the miscategorization of Mercer as a talent consultant, and perhaps misconceptions behind the intentions of the business of the unit that released this report, are being amended, so maybe this story and your publication’s future tenor of reporting on alternatives will change.
Your longtime reader,
_Paul Damon is president and founder of Keramas LLC, a marketing and communications consultancy for the investment management industry. He does not currently work with any providers of hedge funds. Paul can be reached on his Twitter account.
From Paul: For disclosure’s sake: I did some work for AQR Funds (the 40Act side of the business) as part of their account team in 2012 at FTI Consulting. Over the years, I have worked with a number of asset management firms with alternatives products and related interests (service providers to HFs), as well as lobbyists for the HF industry, but am not currently working with any hedge funds. I/Keramas (my consultancy) does generate revenue from firms who compete with hedge funds, but my comment being published shouldn’t make them think twice about continuing to pay me to help them.
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