The prisoners of passive investing

Mon Dec 5, 2011

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Next year’s investment decisions will need to be based on realising investment goals rather than paralysis and passivity

By Susan Barreto

Judging by the same names that keep coming up, alternative investing seems, well, not so alternative any more. In a closer look at the managers favoured by registered investment companies in the US, the convergence of FoHFs and mutual funds just moved a step closer. But what is even scarier is that institutional investors are only a step behind. The brands chosen by RICs yesterday have become the long-term picks of the direct allocators today.

DE Shaw, Brevan Howard, Bridgewater, Elliott Associates, Och Ziff and Winton Capital are just a few of those deeply entrenched in the portfolios of funds of hedge funds (RICS and others), as well as pensions and endowment portfolios. But why are investors not sourcing new talent?

The answer lies beyond returns, beyond investing and beyond the bottom-line good of the pensioner at the end of the food chain. It seems that investors are plagued by a common complaint: fear.

Fear of losing out on future offerings if they terminate a manager that is underperforming; fear of burning bridges prematurely; fear of allocating to a manager that is too small or too new; and one must also not forget the fear of good, old career risk. They may also remember that FoHFs get a bad rap for manager churning and may like the idea of being revered as stalwart long-term investors.

It seems that little thought is given to determining when a manager may have outgrown its strategy; and the current low-performing environment has highlighted that true 'active’ management of multi-manager hedge fund portfolios may very well be dead.

Perhaps institutions are happy with the returns they are getting? After all, who can argue with allocating to Brevan Howard? Both the multi-strategy and global macro funds have been nominated for awards at the annual EuroHedge gala dinner to be held on 26 January in London. In addition to the RICs (see page 14), Brevan Howard can be found in the portfolios of West Virginia Investment Management Board, New Jersey Division of Investment and Rhode Island Employees’ Retirement System (see pages 8-9).

Capula and Marshall Wace have also made the cut at both the upcoming EuroHedge Awards in London and Rhode Island Employees Retirement System and West Virginia Investment Management Board. It might be worth mentioning that Rhode Island is just now beginning to allocate to hedge funds and it has already sourced some of the top names in the industry.

The story is the same in the US. At this year’s AR Awards, Ray Dalio’s Bridgewater Associates took home the Management Firm of the Year prize for the second consecutive year. DE Shaw and Brevan Howard were nominated for other categories, along with York and King Street, still popular among most large US public pension funds, endowments and foundations, and not forgetting the RICs.

Paulson, however, is an example of where past performance does not guarantee future returns. New Mexico Public Employees Retirement Association, New York State Common Retirement, Indiana Public Employees Retirement System and Philadelphia Board of Pensions and Retirement all raced into Paulson from 2008 through 2010 and are still there, despite the Paulson Advantage fund being down over 46% for the year to September.

Asset gathering to earn a steady stream of management fees is now endemic in the hedge fund world, according to the latest Greenwich Roundtable white paper, while for investors – guided by the easy picks of their advisors – it is simply the case that no-one has ever been fired for hiring a brand-name hedge fund. Few have found the courage to ask simple questions suggested by Greenwich Roundtable participants: "Do we have access to first-class deal flow? Can we realistically gain access to top-tier managers, many of whom are closed or consider new investors by invitation only?"

Next year’s investment decisions will need to be based on realising investment goals rather than paralysis and passivity that in turn can trap investors into faulty, short-sighted decision making.

ISSN: 2151-1845 / CDC10004H

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