Hedge funds exit stage left, pursued by bearishness | FT Alphaville

Hedge funds exit stage left, pursued by bearishness

LONDON—World-renowned news and opinion magazine The Economist announced plans to suspend any new online and print content for the next month in an effort to finally allow subscribers a chance to catch up. “It’s only fair to our readers,” said Economist editor Winthrop Parker, adding that there was no reason for subscribers to feel ashamed for not necessarily knowing every last detail about the current economic and geopolitical climate.

Unfortunately, it isn’t true — the above is from The Onion.

The Economist, which continues to print weekly with wild abandon, had a welcome combination of both funny and serious coverage of trends in the hedge fund industry in its latest edition. Serious first:

“I’ve been doing this for 15 years and I’ve never seen as many people give up as in the last three months,” says Luke Ellis of Man Group, a large listed fund. This trend is distinct from the round of closures in 2008. Then, managers were hit by investors’ redemptions and had no choice but to close; today many are electing to walk away.

This is in part because many hedge funds are well below their high watermarks, meaning that they can only charge investors management fees, which at around two per cent is only enough cookie money for a year or two unless one is a ginormous fund. According to Credit Suisse data cited by the Economist, 67 per cent of hedge funds were below their watermarks at the end of 2011.

While returning cash in the face of adverse markets may be the noble thing to do, there is also the risk…

…that high-water marks could skew funds’ investing decisions. Managers who have not earned a performance fee in years could take bolder bets to get back into the black.

Indeed, the FT pointed out in January (using the same Credit Suisse dataset) that leverage has crept up ever so slightly to 2.5 times, off the post-crisis low of 2.4.

To state the bleedingly obvious: incentives to lever up and roll the dice are not the kind that you want the person looking after your money to have.

Some managers have been taking a slightly different tack, seeking to unleash value in their holdings by getting out the quill pens and turning activist.

The overwhelming message though, is that investors are getting more demanding after witnessing underperformance in the industry over the course of the crisis, and strategy and leverage changes are likely to be closely scrutinised.

The Economist published a letter from one fund that has clearly grabbed the bull by its horns (emphasis ours):

Dear investor,

In line with the rest of our industry we are making some changes to the language we use in our marketing and communications. We are writing this letter so we can explain these changes properly. Most importantly, Zilch Capital used to refer to itself as a “hedge fund” but 2008 made it embarrassingly clear we didn’t know how to hedge. At all. So like many others, we have embraced the title of “alternative asset manager”. It’s clunky but ambiguous enough to shield us from criticism next time around.

We know we used to promise “absolute returns” (ie, that you would make money regardless of market conditions) but this pledge has proved impossible to honour. Instead we’re going to give you “risk-adjusted” returns or, failing that, “relative” returns. In years like 2011, when we delivered much less than the S&P 500, you may find that we don’t talk about returns at all.

It is also time to move on from the concept of delivering “alpha”, the skill you’ve paid us such fat fees for. Upon reflection, we have decided that we’re actually much better at giving you “smart beta”. This term is already being touted at industry conferences and we hope shortly to be able to explain what it means. Like our peers we have also started talking a lot about how we are “multi-strategy” and “capital-structure agnostic”, and boasting about the benefits of our “unconstrained” investment approach. This is better than saying we don’t really understand what’s going on.

Some parts of the lexicon will not see style drift. We are still trying to keep alive “two and twenty”, the industry’s shorthand for 2% management fees and 20% performance fees. It is, we’re sure you’ll agree, important to keep up some traditions. Thank you for your continued partnership.

Zilch Capital LLC

Maybe Zilch Capital has been getting some smart beta from European banks and Apple this year. All part of their multi-strategy, capital structure agnostic approach to further enhance relative returns as a leading alternative asset manager, no doubt.

Related links:
Hedgies in flux – FT Alphaville
Hedge funds faulted for not being short-term enough – Reuters
Trimmed by the Hedge Funds – The Psy-Fi Blog