Investment Strategy

Hedge Funds become more fundamental as Investors Shift Interests

The provocative and esoteric world of the hedge fund is slowly turning towards a more traditional fundamental approach to investing. If you look at the typical prospectus of a hedge fund, it will be somewhat vague and furtive in its investment style.

However, with a ten year bull run in the market, major investors in such funds, like pensions and insurance companies, are wanting to allocate more of their portfolio to long positions in the stock market. Often known for taking audacious risks in either large bets or contrarian positions, some are now moving more mainstream.

As the large investors usually do, they come late to the party, but never the less, funds will adapt to meet their needs. Thus the allure of the long stock position. Some of the world’s largest hedge funds, including CQS, DE Shaw, and Man Group, are now employing this formula that simply echoes that more often found in the traditional asset management industry.

Hedge funds like DE Shaw have seen a tremendous shift in their asset allocation models. Those funds managed only $5 billion at the beginning of 2011, but that doubled to $10 billion by 2015 and now stands at $24 billion, making it a major part of DE Shaw’s overall $50 billion of assets. You have to go all the way back to 2007, when hedge funds as a whole outperformed the S&P 500.

If you look at the fees associated with hedge funds and compare that to traditional money managers, one wonders why they would be allocated such an influx of long capital. The traditional hedge fund fee model is 2/20. The average fees hedge funds charge now consists of a 1.43 percent cut for management and another 16.9 percent based on performance, according to Hedge Fund Research. Compare this to their managed fund brethren, who charge half the annual maintenance fee, 0.76%, and don’t even charge a performance fee. How many CFA’s does it take to realize this doesn’t make sense? Money flowing into the hedge fund industry looks as if it may have plateaued. However, my notion is that as long as there is a “secret sauce” behind the curtain, money will continue to flow in.

The likes of college endowment funds and insurance and pensions all have the luxury of time on their side, so they are less likely to be lured into a contrarian or higher risk hedge fund. With that said, the market has an amazing ability to take in every last dollar until it decides to turn and run the other way.

Piling in on the long-term side doesn’t bode well, as we have yet to see what transpires once the market corrects itself. Most analysts believe that volatility is here to stay. As such, those long-only funds will not be able to cover their losses with short positions. The Man Group’s long-only fund suffered a $6.6 billion loss last year. Ouch. That had to be a difficult discourse with shareholders.


Investment StrategyWealth Mgmnt