Showing posts with label hedge funds. Show all posts
Showing posts with label hedge funds. Show all posts

Thursday 16 January 2020

Evaluating Discretionary Stockbrokers and Money Managers

Some stockbrokers function as money managers, having discretionary investment authority over some or all of their clients' funds. Practices such as these may entail serious conflicts of interest since compensation is made on the basis of trading commissions rather than investment results. Nevertheless, you would select a discretionary stockbroker just as you would choose a money manager. The questions to be asked are virtually identical. In both cases, while there are large pools of people from whom to choose, selecting someone to handle your money with prudence and fiduciary responsibility is never easy. 

The ultimate challenge in selecting a stockbroker or money manager is

  • understanding precisely what they do, 
  • evaluating the validity of their investment approaches (do they make sense?) and 
  • their integrity (do they do what is promised, and is it in your best interest?). 




How do you begin to evaluate stockbrokers and money managers? 

There are several important areas of inquiry, and one or more personal interviews are absolutely essential.

There is no better place to begin one's investigation than with personal ethics.

  • Do they "eat home cooking"- managing their own money in parallel with their clients'? 
  • I can think of no more important test of the integrity of a manager and the likelihood of investment success than his or her own confidence in the approach pursued on behalf of clients. 
  • It is interesting to note that few, if any, junk-bond managers invested their own money in junk bonds. In other words, they ate out. 


Another area of inquiry concerns the fair treatment of clients.

  • Are all clients treated equally? If not, why not, and in what ways? 
  • Are transactions performed for all clients contemporaneously? If not, what method is used to ensure fairness? 


A third area of interest concerns the likelihood of achieving good investment results.

  • Specifically, does the broker or money manager oversee a reasonably sized portfolio, or have the assets under management grown exceedingly large
  • One way to judge is to examine the manager's track record since the assets under his or her control reached approximately the current level. Investors can also examine the records of other managers to determine in general how increased size affects performance. 
  • From experience, large increases in assets under management adversely affect returns. The precise amount that can be managed successfully depends on the specific investment strategy employed as well as the skills of the manager under consideration. 


A fourth area of inquiry concerns the investment philosophy of the manager.

  • Does the broker or money manager have an intelligent strategy that is likely to result in long-term investment success? (Obviously, a value-investment strategy would be optimal.) 
  • Does he or she worry about absolute returns, about what can go wrong, or is he or she caught up in the relative-performance game? 
  • Are arbitrary constraints and silly rules, such as remaining fully invested at all times, absent?

Monday 17 April 2017

Concentrated portfolio of stocks or Index funds or Mutual/Hedge funds

How should I invest in the stock market?

Should I invest in my own selected stocks and manage my own portfolio?

Should I entrust my money to the fund managers in mutual funds or hedge funds?

Or, should I just buy an index-linked fund or an ETF?



Investing in mutual funds and hedge funds

The problem here is, as an aggregate, these funds underperform the market, after taking into consideration the costs incurred.  

Over a one year period, these costs maybe small, but over a long period, these costs compounded into a huge amount that is leaked out of your portfolio, not available to you to reinvest into your portfolio.

It is generally sound to avoid these funds, since there are better alternatives.


Investing in index linked funds or ETF

Index linked mutual funds have on the aggregate given you the chance to capture the returns of the market at low costs.    

They have in general outperformed the mutual funds and hedge funds, as a group over the long term.

Due to recent awareness of the performances of the mutual funds and hedge funds due to the higher costs involved, more and more money are flooding into index linked funds or ETFs.


Investing in a concentrated portfolio of  a selected group of stocks

I believe this is possible for those with a good and sound philosophy and method; who are hardworking, knowledgeable and disciplined.

These constitute less than 5% of the investors in the market.

An example of a sound philosophy:
  • Know the business you are investing.
  • The business has durable competitive advantage.
  • The management has integrity and are capable.
  • The company is available at a fair or bargain price.
  • The investing time horizon is long term (> 5 years or more).
  • Dividends are reinvested.
The stock markets have returned averagely about 10.5% per year for a long period.  The returns of the stock market over the short term is extremely volatile; inflation over this short period is small.   On the other hand, the returns of the stock market for any 5 years or more rolling period have always been positive.   Those who choose the "good quality stocks" bought at "bargain prices" can expect to perform better than the average and should have returns better than the 10.5% per year.



In summary:

1.   If you are knowledgeable, do invest on your own.

Own a concentrated portfolio of good quality stocks (those with durable competitive advantage).

Do not overpay to own them.

Keep them for the long term, reinvest the dividends, and allowing compounding to give you the higher returns.


2.   If you are not so knowledgeable, but still intelligent in your investing.

Go for index linked funds.

Do you have the uncanny ability to pick out the best mutual or hedge fund managers?  If you have, you may wish to park your money with them.  If not, avoid these products altogether and go for index linked funds or ETF.










Friday 14 April 2017

Index funds and active management - Warren Buffett is a vocal critic of active management.

Towards his later life, particularly following the global financial crisis of 2007-8, Buffett became an increasingly vocal critic of active management, i.e., mutual funds and hedge funds

Buffett is skeptical that active management and stock-picking can outperform the market in the long run, and has advised both individual and institutional investors to move their money to low-cost index funds that track broad, diversified stock market indices. 

Buffett said in one of his letters to shareholders that "when trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients."

In 2007, Buffett made a bet with numerous managers that a simple S&P 500 index fund will outperform hedge funds that charge exorbitant fees. By 2017, the index fund was outperforming every hedge fund that had made the bet against Buffett by a significant margin.

Thursday 25 October 2012

Benjamin Graham: Mutual Funds


Graham, Chapter 9:
Mutual funds are the subject of the ninth chapter of The Intelligent Investor. Fund performance and the different types of funds available to the investor are covered. 
One of those types of funds is the performance fund, which seeks to outperform the Dow Jones Industrial Average in this case, so they are the more aggressive of the funds. 
Another type, the closed-end fund only offers a specific number of shares at one time, instead of continuously, and is the most illiquid of the bunch. 
The last mutual fund type Graham mentions in this chapter is the balanced fund. These types of funds contain a certain percentage of bond holdings. Even the conservatively investing Graham suggests you would be better off investing in bonds by themselves, rather than mixed in a fund with stocks.


The Intelligent Investor by Benjamin Graham

Friday 4 May 2012

Buffett winning bet that hedge funds can’t beat market


  Mar 21, 2012 – 9:42 AM ET

Nelson Ching/Bloomberg
Nelson Ching/Bloomberg
Warren Buffett made a friendly bet four years ago that funds that invest in hedge funds for their clients couldn’t beat the stock market over a decade.

    By Katherine Burton
Warren Buffett made a friendly bet four years ago that funds that invest in hedge funds for their clients couldn’t beat the stock market over a decade. So far he’s winning.
The wager that began on Jan. 1, 2008, pits the Omaha, Nebraska, billionaire against Protégé Partners LLC, a New York fund of hedge funds co-founded by Ted Seides and Jeffrey Tarrant. Protégé built an index of five funds that invest in hedge funds to compete against a Vanguard mutual fund that tracks the Standard & Poor’s 500 Index. The winner’s charity of choice gets US$1-million when the bet ends on Dec. 31, 2017.
The Vanguard fund’s low-cost Admiral shares returned 2.2%, with dividends reinvested, from the start of the bet through Feb. 29, as stocks rebounded from a 12-year low in March 2009. The hedge funds fell about 4.5%, based on Protégé’s index returns for the first three years and results since then for the Dow Jones Credit Suisse Hedge Fund Index, which has roughly tracked the group of unidentified funds when adjustments are made for extra fees.
“Hedge funds of funds have underperformed because of high fees and mediocre manager selection,” said Brad Alford, head of Alpha Capital Management LLC in Atlanta, which runs a mutual fund of funds designed to replicate the performance of hedge funds with lower fees and the flexibility for clients to pull money out daily. Since 2009, his Alpha Defensive Growth strategy has posted an annual average return of 8.2%, almost twice the return of hedge fund of funds.
Neither Mr. Buffett nor Scott Tagliarino, a spokesman for Protégé, would comment on the bet’s progress.
Assets Decline
Funds of funds have seen clients flee in the past five years. Some of the largest U.S. public pension funds, including those in Massachusetts, South Carolina and New York, started investing directly in hedge funds instead of going through an intermediary in an effort to reduce fees and boost returns.
The amount of money they control has fallen by about one-fifth to US$630-billion as of the end of 2011, compared with a year-end peak of US$780-billion in 2007, according to Hedge Fund Research. Funds of funds were the industry’s biggest investors in 2007, holding about 43% of assets.
Mr. Buffett’s argument, like the large pension funds, is that funds of hedge funds cost too much, according to a statement he posted on longbets.org, a website backed by the nonprofit Long Now Foundation that fosters “long-term thinking.” In addition to the 2% management fee and 20% performance fee that hedge funds typically charge, the funds of funds add another layer of fees, on average 1.25% of assets and 7.5% of any gains, according to data compiled by Bloomberg.
Wheat From Chaff
Protégé said in its statement that because hedge funds can make bets on rising as well as falling prices of stocks, bonds, currencies and commodities, they are able to beat the S&P 500 even after fees, and that sophisticated investors such as fund- of-fund managers “with the ability to sort the wheat from the chaff” will earn returns that amply compensate for the extra costs.
The returns of Protégé’s index from 2008 through 2010, reported in Fortune magazine a year ago by long-time Buffett friend and chronicler Carol Loomis, are similar to those of the Dow Jones Credit Suisse Hedge Fund Index, after adjusting for the added fees charged by hedge fund of funds. That index fell 2.5% last year, and rose 4% in the first two months of 2012.
Protégé took the lead in the first year of the bet as its fund of funds index lost 24% and Vanguard’s fund declined by 37%. Buffett narrowed the gap in subsequent years. The S&P fund returned 27% in 2009, compared with a gain of 16% for the hedge funds, according to Fortune. The stock fund rose 15% in 2010 as the hedge funds advanced 8.5%.
Overtaking Hedge Funds
The 81-year-old Buffett, who is chairman of the holding company Berkshire Hathaway Inc., ended last year neck and neck with the Protégé funds as the Vanguard fund climbed by 2.1% and the Protégé hedge funds lost an estimated 3.75%.
The first two months of this year pushed the Vanguard fund ahead as stocks returned 9%, more than twice the gains of hedge funds.
Mr. Buffett, who told Loomis in 2008 he placed his chances of winning at 60%, had originally suggested a bet against single-manager hedge funds. Had he found a taker, he would be trailing by about 6%age points based on the Dow Jones Credit Suisse index.
If Mr. Buffett had bet returns of his own holding company against the performance of hedge funds, he’d be even farther behind. Berkshire Hathaway shares have slumped almost 17% since the end of 2007.

Friday 19 August 2011

Special report: The perils of Paulson

Special report: The perils of Paulson
Written by Reuters
Thursday, 11 August 2011 06:52




NEW YORK/BOSTON: The crown may be slipping fast from billionaire trader John Paulson's head.

The hedge fund manager became an overnight sensation in 2007 by betting big and early on the collapse of the U.S. housing market, and then doing much of the same on a surge in gold prices, Reuters reported on Wednesday, Aug 10. But he is now emerging as one of this year's big losers in the $2 trillion hedge fund industry.

His Paulson & Co. hedge fund firm, which managed $38 billion as recently as this past March, is down to about $35 billion as of the first week of August, and it shrinks a little bit more with every big drop in the U.S. stock market.

One of Paulson's two main funds is now down more than 30 percent this year, the firm has reported to clients, compared to a much smaller 6.1 percent decline for the average hedge fund, according to Hedge Fund Research.

The problem for the 55-year-old manager: His equally daring bet that the U.S. economy and housing market would rebound strongly from the financial crisis -- a big wager that looked prescient a year ago -- isn't panning out as planned.

Paulson's funds have amassed huge, mutual fund-style stakes in shares of financial institutions like Bank of America, Citigroup, Hartford Financial, Popular Inc. and American Capital. But these are ringing up hefty losses.

And with fears of a double-dip recession in the United States mounting, coupled with this month's 13 percent plunge in the S&P 500, the talk is growing on Wall Street that unless Paulson can quickly turn things around, the hedge fund king could be hit with a wave of year-end investor redemptions.

"There are many investors who have experienced great gains with John Paulson, but a lot of the money has come into his funds after those great gains were achieved, and the relative newcomers are seeing a lot of heavy losses," said Daryl Jones, director of research at Hedgeye Risk Management, which sells investment research to institutional investors. "I would imagine it would lessen their appetite to stay with someone who is supposed to be a big superstar but is down double digits right now."

Paulson, through a firm spokesman, declined to comment. But people close to Paulson point out that other than hedge fund guru George Soros, no one has consistently made more money for clients than the man referred to by his friends and associates as "J.P."

LOYALTY TEST

This year, however, his investors' loyalty is being put to the test.

Maybe no one single trade has come to symbolize Paulson's bullishness on the U.S. economy more than Bank of America. By August 9, the troubled lender's shares were down 43 percent this year, reducing the value of the 124 million shares Paulson owned as of March 31 by $784 million. Paulson is believed to have sold some of his Bank of America shares as the stock has plunged toward the $7 mark, but the firm has refused to comment on its current position. (link.reuters.com/gem23s)

The picture isn't much prettier for Paulson's large share holdings in Citigroup, Popular (formerly Banco Popular) and SunTrust Banks. The value of Paulson's equity stake in those three banks, assuming the funds haven't sold any shares since March 31, would have declined by more than $800 million over the past four months.

And then there is Sino-Forest, the troubled Chinese forestry company. Paulson absorbed a $500 million loss on the stock in June after allegations of accounting irregularities at the Hong Kong-based company surfaced earlier in the month. (link.reuters.com/hem23s)

The series of missteps is tarnishing the near god-like status the former Bear Stearns trader has earned over the past few years.

Much of the $20 billion in outside investor money Paulson manages has come from pension funds and clients who bought in after he made $15 billion for the firm in 2007 on his well-chronicled subprime mortgage trade. Paulson raised that money by making his hedge fund one of the most widely available to wealthy customers of dozens of large and small brokerage firms.

Now some investors who got in after Paulson's so-called Alpha moment are getting out this fall, or are seriously considering doing so at year's end. Some in the industry are wondering whether Paulson's flagship Advantage funds, with $15 billion in assets, are too large and thus not nimble enough to navigate increasingly choppy markets for stocks.

Francis Bielli, executive director of the Philadelphia Board of Pensions and Retirement, said on June 30 that the board voted to submit a redemption for its entire $12.4 million investment in the Paulson Advantage fund. The Philadelphia municipal pension, which manages $3.7 billion, had originally invested $15 million with Paulson in December 2008. In June 2010, it withdrew $4 million of that money.

Joelle Mevi, of the Public Employees Retirement Association of New Mexico, invested with Paulson Advantage fund in March 2010. She is holding tight for the moment. But she says the $11.8 billion public pensions administrator is keeping a close eye on Paulson's performance and is concerned about his "exposure to financials."

Paulson won't comment on investor redemptions, but he is trying to put his clients at ease. On August 5, the firm took the unusual step of sending out a letter to investors, informing them that for the period ending September 30, investors were seeking to withdraw $420 million from the firm. The letter says that's "less than the average quarterly redemptions over the past 2 years." But the firm was silent about potential year-end redemptions.

PARTY CRASHES

Hedge fund industry watchers say what's gone on at Paulson this year is indicative of what often happens with hot managers as they get big and take larger and larger bets.

A study last year by research firm PerTrac Financial Solutions, which looked at the performance of thousands of hedge funds over a period of years, found that "investors who wish to maximize return should start their search by looking for younger funds." The report also found that except for 2008 - one of the worst years ever for the hedge fund industry - smaller funds have tended to outperform large hedge funds over the long haul.

Patrick Adelsbach, a partner and director of event-driven research at hedge fund consulting firm Aksia, says whenever a hedge fund gets too large, there is a concern about a manager getting "boxed in" by taking outsized stock positions. He says the irony is that the more assets a manager has to deploy, the more ordinary the trades can become.

When analyzing hedge funds for pension fund clients, Adelsbach says he keeps an eye out to make sure a manager isn't starting to emulate a "mutual fund strategy" in its stock trades.

In some respects, Paulson's $15 billion Advantage funds have come to resemble a mutual fund - except that they charge the much larger fees of a hedge fund.

As of March 31, Paulson was listed as one of the largest institutional shareholders in at least eight companies, including Hartford Financial, MGM Resorts International, Mylan Inc., SunTrust, Popular, XL Group and American Capital.

In the case of MGM Resorts, Paulson's firm had 43.8 million shares as of March 31, nearly three times as many shares as four separate Vanguard funds had invested in the gambling and resort company.

Alan Gold, a Chicago resident who invests in hedge funds and real estate, says he has shied away from Paulson, although he's been pitched a number of times. Gold says he tends to avoid large hedge funds because they can be "unwieldy" to manage, which makes it harder "to find good quality investments."

Paulson's enormous 124-million-share bet on Bank of America is a classic example of a bold thematic play on a beaten-down stock.

The move can look brilliant when the shares rise - which initially happened for Paulson when he first bought nearly 168 million shares of Bank of America in summer 2009. At the time the stock was selling for around $11 and briefly traded as high as $19 in April 2010. But when things go the other way and the stock is falling like a knife, it's hard to quickly get out of that position.

In a July conference call with investors, Paulson conceded he had too much exposure to financial stocks and was reducing holdings in bank stocks with problematic mortgages such as Bank of America. But he has not offered any firm guidance on what his funds have been selling. (link.reuters.com/fem23s)

The issue of size has been raised before. In a 2008 year-end investor letter, the manager wrote investors often "ask if our large asset base impedes our ability to maintain high levels of performance." He continued: "Although that may be the case in the future, we have not reached that point yet."

GOLDEN DAYS

Some of Paulson's most attractive investment opportunities are concentrated in some of the smallest funds he manages.

His $1 billion Paulson Gold Fund, launched last year, is soaring ever higher, with the price of the precious metal reaching new heights every day. With gold now selling for around $1,792 an ounce, the Gold Fund, which had been up 2.7 percent through July could be up as much as 6 percent for the year, an investor said.

The $3 billion Paulson Recovery Fund, which is flat for the year, is booking a whopping 200 percent paper gain on its $150 million investment in OneWest, a California-based bank that emerged from the wreckage of failed savings-and-loan IndyMac. The bank, which Paulson and other deep-pocketed investors bought with help from the Federal Deposit Insurance Corp., is potentially eyeing an initial public offering next year.

Also up is the Paulson Real Estate Recovery Fund. The small, $350 million private-equity-style fund is buying vacant land with approval rights to build hundreds of single-family homes. It targets failed complexes in Colorado, Arizona, Florida and California. The fund gained 22 percent last year.

Paulson believes that in five years time, the housing market will have recovered enough to enable the small fund to make a bundle from reselling the properties, which it acquired at bargain basement prices. In the meantime, Paulson is earning income as a landlord by renting out some of the luxury homes that were previously built before the developers went bust.

But the majority of Paulson investors aren't in any of these funds, and have their money in the beleaguered Advantage funds.

Paulson, who Forbes says has an estimated net worth of $16 billion, has pointed out that he and his employees are co-investors along with his customers. So the manager and his employees are sharing in some of the suffering his clients are enduring.

It's true that about 40 percent of the firm's $35 billion in assets is either Paulson's money or that of his employees. But the firm does not require its employees to pay the typical 1.5 percent asset management fee and the 20 percent performance fee the fund collects from outside investors.

Also, a good deal of the money invested by Paulson and his employees in the Advantage funds is committed to a so-called gold-denominated share class, which is performing far better than the plain vanilla version of the funds. But many of the Wall Street brokerage houses that sell access to Paulson funds don't offer the gold-denominated alternative, which Paulson introduced in 2009. About a third of the $35 billion Paulson manages is committed to the gold-share class.

For many investors, the inability to access smaller funds or the gold-share class of the Advantage funds didn't matter when Paulson was posting high double-digit returns. But with the Advantage funds losing ground, more on Wall Street are starting to wonder about why Paulson moved so actively to rake in outside money the past few years.

Paulson was largely an unknown figure before the subprime bet paid off. He toiled in relative obscurity and managed just several billion dollars for wealthy investors and small endowments from his mid-town Manhattan office. Until recently, he took the bus to work, say investors who know him.

But the subprime bet, chronicled in the book "The Greatest Trade Ever" by Wall Street Journal reporter Gregory Zuckerman, catapulted him to rock star status and made many millionaires want to invest with him.

COME ON IN

Paulson did much to open the doors. He made his funds - in most cases just the Advantage funds - available to wealthy customers of Wall Street brokerages and small investment advisory firms.

These distribution channels, or "platforms" in hedge-fund jargon, are a cheaper way for wealthy individual investors to access Paulson. The manager normally has a $10 million investment requirement. But for as little as $100,000, an investor with several million dollars in assets can put money into a Paulson fund through these brokerage firms.

An increasing number of hedge funds, like D.E. Shaw & Co., Israel Englander's Millennium Management and Daniel Loeb's Third Point, are available to wealthy clients of UBS, Morgan Stanley and Bank of America's Merrill Lynch. But few funds are on as many of these platforms as Paulson.

In the United States, wealthy individuals can also turn to smaller firms like Mount Yale Capital Group, Luminous Capital, Krusen Capital, Altegris Investments and CAIS Capital. In Europe, Paulson funds are sold through Lyxor and Deutsche Bank. In Australia and New Zealand, a small firm called Ashton Funds sells access to Paulson.

To tap into these large brokerage and smaller investment advisory firms, a few years ago Paulson hired Claudio Macchetto from Citigroup's alternative investments group to serve as director of global platform operations. Macchetto, who reports to Paulson investor relations head James Wong, heads his own team of a half dozen employees.

Overall, nearly two-dozen of Paulson's 120 employees are involved in either investor relations or marketing. That's considerably more than other leading funds.

Dan Loeb's Third Point, with about $8 billion under management, has just four people in investor relations and marketing. Steven Cohen's SAC Capital Advisors, with $14 billion under management and more than 800 employees, has about a dozen people in marketing and investor relations.

Och Ziff, founded by Dan Och in 1994, the same year Paulson went out on his own, has about 20 investor relations and marketing people, out of more than 420 employees.

Paulson's large marketing team has enabled the firm to maintain a consistent flow of new investor money coming into the firm, even as it regularly sees several hundred million dollars in redemption each quarter, according to the August 5 memo from Wong, Paulson's investor-relations director. Paulson loyalists point out the fund's assets have largely held stable the last few years and more of its growth has come from performance than taking in net new money.

For a large fund, amassing money to manage - what's called "asset gathering" in the industry - can be lucrative in and of itself.

Using a back of the envelope calculation, Paulson is taking in about $300 million a year in asset management fees from his outside investors.

"I completely understand why Paulson would want to build out exposure to independent firm platforms like ours, because it allows funds to access a different advisor and client base," says David King, a partner with U.S. Capital Advisors in Dallas, a firm that manages $1.5 billion and offers customers an opportunity to invest in the Advantage funds through an arrangement it has with CAIS Capital.

"But I am puzzled why the Paulson funds are offered on so many of the large bank and wirehouse platforms," says King.

Earlier this year, Paulson showed up at an event sponsored by UBS, which began selling Paulson's Advantage fund to its high-net worth customers last year. At that meeting, Paulson talked about why he was so bullish on shares of casino company MGM Resorts. In March, Paulson reported owning 43.8 million shares. But the stock has been a bust this year. MGM Resorts is down about 25 percent as of August 9.

Not everyone sees all this marketing by Paulson as a bad thing. It may have helped him develop a loyal investor base. He's known for throwing lavish investor gatherings in Las Vegas and Paris. Such attention may be one reason redemptions for the third quarter are running relatively low, despite the poor performance of the Advantage funds.

In fact, new money is still coming in. In the August 5 letter on redemptions, Wong hinted at that, saying: "redemptions may be offset by subscriptions."

The $2.1 billion Houston Municipal Employees Pension System put $10 million into the Advantage fund in March. And a spokesman for the $18 billion Texas County & District Retirement System, which last year invested $40 million with Paulson, says the public pension has no plans to redeem.

Dr. Lewis Feder, a Manhattan plastic surgeon with a list of celebrity patients, says he has no plans to bolt from Paulson, with whom he has invested for nearly a decade. Feder says he has money in six Paulson funds, including the small real estate recovery fund.

"He has a remarkable team employed around him," said Feder. "He doesn't go out looking for money as much as it comes to him."

A big test for investors, even Paulson's most loyal ones, comes in December, when the next opportunity to exit the fund comes up.

http://www.theedgemalaysia.com/first/191071-special-report-the-perils-of-paulson.html

Sunday 14 August 2011

Hedge fund investors way off target on market chaos

By Sean Farrell
Saturday, 13 August 2011
Europe's bans on short selling cast hedge funds in their usual role as shadowy bogeymen, profiting from the misfortunes of others, but some of the world's biggest funds have taken a bath amid the wreckage, it has emerged.
The biggest name to suffer is John Paulson, the US investor who made billions by taking short positions against US sub-prime mortgages before the credit crunch erupted. Mr Paulson's Advantage funds, which oversee about $17bn ($10bn), are down about 10 per cent this month and 31 per cent this year. After making his fortune by betting against the financial sector, Mr Paulson is losing money for his clients because he invested in a US recovery with big holdings in Bank of America and Citigroup.
Other US titans to feel the heat include William Ackman, whose Pershing Square fund is down about 10 per cent this year. In the UK, Lansdowne Partners' UK Equity Fund fell 4.4 per in the week ended 5 August and is down 16 per cent this year.
John Godden, the head of IGS, the hedge fund consultant, said: "There are a number of managers who are long the wrong things or short the wrong things at the moment. They have been hurt and they are no different from any other investor."
As always, there have been winners. Brevan Howard, the giant UK-based fund, was up 2 per cent on the week last Friday and 7 per cent on the year. The "macro" fund bets on broadeconomic trends, giving it room for manoeuvre. 36South, the UK-based "doomsday" fund, is also ahead.
Mr Godden said hedge funds would outperform clients' equity holdings in July and August and that the sector was not in crisis. "It will be a fairly short, sharp loss in asset value, but some of the big names fabled for getting it right more than not have got it wrong this time."


http://www.belfasttelegraph.co.uk/multimedia/archive/00615/TONI_TERRY_1_615742a.jpg

Saturday 6 November 2010

Why are passive funds not more popular? The key to successful active investing – it is vital to monitor your portfolio. Yet many individual investors fail to do this.

Keep your investments on track


Funds that passively track the market are less popular than those with active managers, who try to beat the market. But some say they offer more certainty for lower charges. Which should you choose? Niki Chesworth investigates.


Investments advice image
Active approach: whether you choose a tracker or a managed fund, the key is to keep an eye on their performance
Warren Buffett, the investment guru, has said the best way for most investors to own common stocks is through an index fund that charges minimal fees, saying they will "beat the net results delivered by the great majority of investment professionals".
Tracker funds are not only a lower-cost way to invest — because they do not have the expense of paying a team of active fund managers — they offer the certainty of passively tracking a given stock market index. They therefore should not significantly underperform the market, something actively managed funds cannot guarantee.
So it may come as no surprise that the total amount invested in tracker funds managed by UK investment companies soared from £20bn in 2008 to nearly £28bn at the end of last year, according to the Investment Management Association (IMA).
But delve behind these figures and it's apparent this increase was not because these funds were increasingly popular with investors — merely a reaction that tracker funds track the market and the markets bounced back sharply.
Only 5.5pc of all funds under management are held in tracker funds according to the IMA but when it comes to sales, they are attracting just 2.5pc of individual investors' money.
With criticism in the media that investment charges are impacting on the performance of some actively managed funds – as well as reports that some active managers fail to match their benchmark index let alone beat it – why are passive funds not more popular?
"While trackers appeal to institutional investors such as pension funds and charities, which have long-term objectives and are in the main happy to accept market risk but at no more cost than is necessary, individual investors want their fund managers to deliver alpha, they want to beat the market," says Justine Fearns, research manager of independent advisers AWD Chase de Vere.
"Investors believe that if they pick the right active managers, they may be able to get that extra bit of performance."
Fearns also believes the poor sales of trackers is a reaction of the stock markets. She says: "Traditionally, trackers are used in more developed markets where news and information is readily available and it has been more difficult for active fund managers to consistently beat the market.
"In contrast, information is not always as free Ḁowing in underdeveloped markets, which creates more opportunity for active fund managers to beat the market.
"Similarly, in volatile and uncertain markets, like we have seen recently, individual assets can become mispriced, creating investment opportunity. This applies to both developed and underdeveloped markets and lends itself far more to an active stock-picking approach.
"If you know the market is going to perform strongly then you can get a good market return quite cheaply through a tracker. But when the markets start to come down, you will suffer the full effects of market falls with a tracker fund. So investors can tactically look to protect the downside with an actively managed fund."
Bearing the brunt of short-term falls in markets is one reason why those prepared to take a long-term view — institutional investors — may see the attraction of tracker funds better than individual investors.
Tracker funds have to blindly follow their given benchmark index which can cause sharp falls in the fund's value.
"This is the major drawback of tracker funds," says John Kelly of Chelsea Financial Services. "Even if the sector is overbought or likely to fall, the tracker has to buy it because it has to track the whole of the market."
Fearns says that low sales of tracker funds may also react investors' financial objectives.
"With interest rates low, many investors are looking for income from their portfolio and while a tracker will have an element of yield it will not match that paid by the best equity income and bond funds," she says.
The issue of tracker fund performance has also come under the spotlight. Some trackers buy shares in all the companies that make up the index they follow. Others use complex financial instruments to track that index. Although both types aim to track their benchmark, performance can still vary – and once charges are deducted there can be a consistent slight underperformance.
One recent survey found that while the FTSE All Company sector grew 372.50pc over the last 20 years, tracker funds showed just 330.9pc growth. However, much depends on which indices you compare — among the top 20 UK funds over the past five years is a mid-cap tracker which beat most of the 300 funds in the UK All funds sector.
However, the same claims of underperformance can also apply to actively managed funds – but with actively managed funds this can be far greater.
"There are some poorly performing active funds but if you do the research and get the right advice, you should consistently outperform the benchmark," adds Chelsea Financial Services' Kelly.
"However, with actively managed funds you do need to actively review them – ideally at least every quarter – as the funds you need to hold will change."
This is the key to successful active investing – it is vital to monitor your portfolio. Yet many individual investors fail to do this.
And performance also depends on what investors track.
Trackers are not confined to just the UK. It is possible to track global technology stocks, the global health and pharmaceuticals index and the major markets around the world — from Japan to the US and Europe — gaining access to sectors and geographical diversity for less than an actively managed fund and without the risk of buying the "wrong" fund that underperforms the benchmark.
So which is best?
"There is a place for both types of investment style – a tracker could provide long-term capital growth, but active managers may be able to outperform the market," says Fearns. "It's about balance — a balance of investments, risks and management styles."
However, investors who are passive about monitoring and reviewing their active funds may be better off with passive investments. John Kelly sums up the problem: "Inertia is the biggest destroyer of returns."
Written by Telegraph.co.uk as part of Smart Investment Month in association with Legal & General Investments

http://www.telegraph.co.uk/sponsored/finance/smart-investment-guide/8101976/Keep-your-investments-on-track.html?utm_source=tmg&utm_medium=TD_8101976&utm_campaign=lg0611

Sunday 13 June 2010

Learning to Love Hedge Funds

THE SATURDAY ESSAY
JUNE 12, 2010

Learning to Love Hedge Funds

Hedge funds have been reviled as slick opportunists that fanned the flames of the collapse. Yet Sebastian Mallaby argues that they hold the key to a more stable financial system

The first hedge-fund manager, Alfred Winslow Jones, did not go to business school. He did not possess a Ph.D. in quantitative finance. He did not spend his formative years at Morgan Stanley, Goldman Sachs or any other incubator for masters of the universe. Instead, he studied at the Marxist Workers School in Berlin, ran secret missions for a clandestine anti-Nazi group called the Leninist Organization and reported on the civil war in Spain, where he hitch-hiked to the front lines in the company of Dorothy Parker. It was only at the advanced age of 48 that Mr. Jones raked together $100,000 to launch a "hedged fund," setting himself up in 1949 in a shabby office on Broad Street. Almost by accident, Mr. Jones improvised an investment structure that will survive for years to come.
[Cover_Main]JT Morrow
Hedge funds account for a huge share of trading in financial markets, and have grown to a scale that would have astonished Mr. Jones, amassing roughly $2 trillion in assets. Success has come with notoriety: the Securities and Exchange Commission is suspicious of hedge funds' fast trading algorithms, which some blame for last month's "flash crash" in U.S. stocks. Reformers in Congress are threatening to bring hedge funds to heel by forcing them to register with the SEC and perhaps to hold more capital. Hedge-fund managers such as Raj Rajaratnam of the Galleon Group are being investigated for insider trading, and recently Art Samberg and his late firm, Pequot Capital Management, settled a complaint with the SEC, agreeing to a fine of $28 million. But although hedge funds are often blamed for excesses, Mr. Jones's investment structure holds the key to a more stable finance, to an extent that Washington's reformers fail to understand.

A History of Hedging

See a timeline of Alfred Winslow Jones's life and career.
After the 1929 crash, investors had fled the market in droves, and the bustling brokerages had fallen quiet; it was said that you could walk the famous canyons near the stock exchange and hear only the rattle of backgammon dice through the open windows. The few obstinate souls who opted to work in money management joined firms such as Fidelity and Prudential, which behaved as conservatively as their names implied. But Mr. Jones was cut from different cloth and he reinvented capitalism on Wall Street.
Mr. Jones's hedge fund, like most later hedge funds, embraced four features. To begin with, there was a performance fee. Mr. Jones reserved 20% of the fund's investment gains for himself and his team, invoking the Phoenician sea captains who kept a fifth of the profits from successful voyages. Mr. Jones's portfolio managers hustled harder than rivals at traditional money-management firms: They called more people, crunched more numbers and made decisions faster. At the same time, the Jones men were deterred from taking crazy risks. They were required to keep their own capital in the fund, so that mistakes would cost them personally.
Mr. Jones's second distinguishing feature was a conscious avoidance of regulation. In his previous life as an anti-Nazi agent, Mr. Jones had kept a low profile. As a hedge-fund manager, likewise, Mr. Jones escaped the attention of regulators by never advertizing his fund; he raised capital by word of mouth, which sometimes meant a word between mouthfuls at his dinner table. Unhindered by the government, Mr. Jones expected no help from it either. The Jones men knew that if they mismanaged their risks, their fund would blow up—and nobody would save them.
[CovJump2]Harvard University
Alfred Winslow Jones's 1919 Harvard yearbook
Thirdly, Mr. Jones embraced short selling. In the 1950s as now, speculating on the prospect of corporate failure was seen as almost un-American. But Mr. Jones described it as "a little known procedure that scares away users for no good reason." By being "short" some stocks, he hedged his "long" investment in others.
By insulating his fund from market swings, Mr. Jones cleared the way for his fourth distinctive practice, which was later to become the most controversial one. Because he had hedged out market risk, he felt free to embrace more stock-specific risk, and so he magnified, or "leveraged," his bets with borrowed money. Between 1949 and 1968, Mr. Jones's partnership earned a cumulative return of just under 5,000%.
Bloomberg News
James Simons in 2007
Mr. Jones inspired a wave of imitators in the late 1960s, including the compulsive trader Michael Steinhardt, who opened a small operation in 1967, and the Hungarian philosopher-financier George Soros, who started his own Jones-style fund two years later. As the successor hedge funds grew, they ad-libbed their own variations on Mr. Jones's original model. Mr. Steinhardt started out as a long/short stock investor, but he found his niche as a gun-slinging market maker for outsized blocks of stock. He was a human version of today's fast-trading computerized hedge funds—those "flash traders" that excite the SEC's suspicion. Mr. Soros evolved too, triggering a decline in value of foreign currencies from Britain to Thailand by selling them short.
As hedge funds improvised new ways of getting rich, they didn't always need the tools that Mr. Jones had relied on. Julian Robertson's storied Tiger Fund, launched in 1980, began as a faithful imitator of Mr. Jones; but when Tiger negotiated the purchase of the Russian government's entire stock of nongold precious metals in 1998, leverage mattered less than the security around the train that was to bring the palladium from Siberia. Four years later, a swashbuckling West Coast fund named Farallon swooped into Indonesia and bought the controlling stake of the country's largest bank. The chief ingredient for this trade was neither hedging nor leverage but nerves—Indonesia had recently experienced a currency collapse and a political revolution.
Getty Images
Julian Robertson in 1997
Light regulation has allowed Mr. Jones's descendants to seize opportunities as they arise—when Farallon was not buying a bank in Indonesia, it was speculating on corporate mergers, distressed debt or a water project in Colorado. Equally, the freedom to go long and short has permitted hedge funds to express investment views with precision. Rather than simply buying a stock or a bond whose performance will reflect currency shifts, interest rates, trends in the broad market, and so on, a hedge fund can hedge out the risks on which it has no view, isolating the particular risk on which it has a real insight.
In the 1960s, the Jones men would show up at the office of the Securities and Exchange Commission to read key releases the moment they came out, stealing a march on sleepier rivals who waited for the information to arrive in the mail. In the 1980s, likewise, Julian Robertson maintained two giant Rolodexes; when compromised Wall Street salesmen pitched a buy recommendation his way, he would pump information out of his network to get the real story on the company. Once, when a Robertson lieutenant heard that a car maker's latest model was prone to break down, he bought two of the suspect vehicles and had them independently tested. When the mechanic confirmed there was an engine flaw, Tiger took a short position in the manufacturer.
Other hedge-fund innovations have been bracingly complicated. James Simons, who emerged as the industry's top earner in the past decade, built his fortune on mathematics, particularly the sort used in military cryptography. By discerning patterns in price movements that were invisible to others, his team constructed a black box that earns billions of dollars annually.
[Hedge_Soros]Getty Images
George Soros in 2001
Because they are largely free of regulatory impediments, and because their reward structure has attracted the best brains, hedge funds have continued in the Jones tradition of outperforming rivals. Whereas mutual-fund managers, as a group, do not beat the market, the best analysis suggests that hedge funds deliver value to their clients. In a series of papers, Roger Ibbotson of the Yale School of Management has examined the performance of 8,400 hedge funds between 1995 and 2009. After correcting for various biases in the data, and after subtracting hedge funds' large fees, Mr. Ibbotson and his co-authors conclude that the average fund generates positive "alpha"—that is, profits that could not be earned from exposure to a market index. In the United States, only rich individuals and institutions are allowed to reap the benefits of hedge funds. But in Europe and Asia, they are increasingly marketed to ordinary savers.
Of course, neither endowments nor individuals should put all their money in hedge funds; like any investment, they can blow up spectacularly. The most famous hedge-fund collapse came in 1998, when Long-Term Capital Management lost almost $6 billion. Eight years later, a Ferrari-driving 32-year-old trader at a fund called Amaranth lost $6 billion on disastrous gas bets; a year after that, several quantitative funds hit trouble all at once, setting off a panic known as the "quant quake."
But even these exceptions to hedge funds' generally good performance serve to underline one of their virtues. When Amaranth failed, another hedge fund named Citadel swooped in to buy the remains of its portfolio—one hedge fund had caught fire, but a second stabilized markets by acting as the fireman, and taxpayers did not have to cover any of the losses. Likewise, the quant quake of 2007 was over even before the public realized it had begun. The one partial exception was Long-Term Capital, whose failure was destabilizing enough to cause the New York Fed to broker a $3.6 billion rescue. But even in this case, public resources played no part in the bailout: The Fed convened Long-Term's bankers and told them to cough up the money to stabilize the fund.
The independent culture of hedge funds stood them in good stead during the recent mortgage bust. Spurred by the carrot of the performance fee, a then-obscure manager named John Paulson created a $2 million budget to buy the largest mortgage database in the country and hire extra analysts to figure out patterns in default rates. Meanwhile, because of the stick of having their own savings at risk, hedge funds that did not undertake similar research at least had the wit to avoid buying subprime paper. Lazier investors piled into collateralized debt obligations on the strength of their triple-A seal of approval. But most hedge funds were too careful to rely on the advice of ratings agencies.
In 2007, the year the mortgage bubble burst, hedge funds were up 10%—not bad for a crisis. Even more remarkably, the subgroup of hedge funds specializing in mortgages and other asset-backed securities was flat for the year—in other words, the hedge funds that might have been expected to get hit generally dodged the bullet. In 2008, admittedly, the turmoil following the collapse of Lehman Brothers hurt hedge funds' returns. But even then, they did better than their peers. They were down 18 % by the end of the year, a decline half as severe as that of the stock market.
The real humiliation of 2008 did not befall hedge funds. It befell banks, insurers, government-chartered housing lenders, and money market funds—and especially the mightiest of all Wall Street titans: investment banks. Until the financial crisis, the brain-power of these behemoths was presumed to be the force that made global markets work. If you were impertinent enough to ask how trillions of dollars of exotic trades could slosh across borders without risking a breakdown, the answer was that Lehman Brothers and its ilk had designed the instruments, modeled the risks, and had all bases covered.
Now that this answer has been exposed as a lie, the puzzle is how to erect a new scaffolding for global finance. The leading answer in Washington, expressed in the reform package emerging from Congress, is to regulate the investment banks and other traditional risk takers. This is a worthy project that must be attempted, but it would be naïve to expect too much from it. The crisis proved the fallibility of regulators from the Securities and Exchange Commission to the respected Financial Services Authority in London to the highly professional Federal Reserve. When multiple overseers fail in multiple places, one must accept that even smart reforms may not change the pattern decisively.
The crisis also demonstrated flaws in large financial firms. These start with the too-big-to-fail problem. Large banks cannot be allowed to go down; knowing that, their creditors lend without monitoring their risks; as a result, their risk-taking is undisciplined. At the same time, each trading desk within a large banking supermarket has strong reason to load up on risk. If its bets come good, huge bonuses will ensue. If they go bad, the losses will be spread across the whole institution.
Given the difficulties with financial reform, legislators should embrace a complementary approach: As well as struggling to tame financial behemoths, they should promote boutique risk takers. With only a few exceptions, hedge funds have the powerful virtue of being small enough to fail; indeed, some 5,000 went out of business in the course of the past decade, and none imposed losses on taxpayers. Mythology notwithstanding, the average hedge fund's leverage is more sober than that of banks and investment banks.
The question for policy-makers is what kind of financial institution will absorb risk most efficiently—and do so without a backstop from taxpayers. The answer awaits discovery in the story of A.W. Jones and his descendants. The future of finance lies in the history of hedge funds.
Sebastian Mallaby is the Paul A. Volcker Senior Fellow for International Economics at the Council on Foreign Relations, where he directs the Maurice R. Greenberg Center for Geoeconomic Sudies. This article is adapted from "More Money Than God: Hedge Funds and the Making of a New Elite," to be published by the Penguin Press next week.