By Nick Evans
Well, it certainly didnt take long for the
reverse-indicator properties of this column to reassert
themselves in 2012.
Barely was the ink dry on my comment in January
highlighting the appeal to investors of systematic strategies
in a difficult environment for discretionary managers and
fundamental stock-pickers than equity markets were
taking off like a rocket, taking those very same fundamental
stock-pickers with them and leaving quant-based funds trailing
in their wake.
Long-biased long/short funds have been particular
beneficiaries none more so than value-based investors,
most of whom were pulverised (again) in 2011 and who believe
that market dynamics are now firmly back on their side after a
prolonged period when fundamental value has been largely
ignored by the market in favour of macro factors.
It may well be that these types of long/short equity funds
are indeed the ones that are best placed to generate high
returns particularly if the risk-on surge fuelled by
central banks flooding the system with cheap liquidity proves
more durable than the rallies of last year.
For many investors, any additional beta exposure to equities
at a time of such acutely uncertain and changeable
underlying market conditions, set against a cloud-covered macro
backdrop is the last thing that they need from their
hedge fund managers right now.
But risk needs to be seen as a spectrum and the
beauty of hedge funds is that there is something for everyone,
all the way from the low-vol, capital-preserving market-neutral
type funds at one end to the bat-swinging, high-conviction
risk-takers at the other.
And the key thing is for investors to know what they are
buying and, just as importantly, for the managers to
know what they are selling.
For all the buoyancy so far this year, there is plenty of
uncertainty around and the bull and bear cases for
markets look equally compelling. If bull markets do indeed
climb a wall of worry, there is no shortage of that about.
Global economic prospects may look a good deal better than
they did a few short months ago (in the US, in China and
for the time being at least in Europe, thanks to the
ECBs LTRO quantitative easing lifeline). But
geo-political developments in Europe, the Middle East
and elsewhere look increasingly worrisome.
Fundamental stock-picking analysis may have reasserted
itself again as the principal driver. But the macro driver
hasnt gone away.
In confused (verging on bi-polar) and very changeable
markets, the need for true alpha is greater than ever. And it
is more important than ever for managers to understand where
their alpha-generating skill lies and to be able to
communicate that to investors.
Some managers are brilliant stock-pickers. Some are
brilliant market-timers. But very few are good at both. And the
biggest lesson of 2011 is perhaps that too many managers were
trying to do both and succeeding only in bamboozling
themselves and their investors.
Finding investors who share a managers view and their
tolerance for risk and who are happy to have their money
managed in the same way as the manager likes to run their own
is the greatest challenge for any manager, just as it
for the investors themselves.
For managers, it involves understanding and
explaining what you are good at, what you are not good
at, what kind of a manager you are and how you are different
from others. And that is a good deal harder and more
complicated than it sounds.
Conviction is all very well, but conviction alone can be
dangerous. And it requires more than just self-belief to earn
and retain the trust of investors.
Self-awareness, communication, honesty and humility are all
important too and yes, a degree of bravery too.
Those are hard things to practise and even harder things to
convey to others. Analysing and communicating instinct is never
easy. But that is what investors need to see. They need to feel
that there is a process, or at least a psychology, that they
can understand and which rationalise to themselves and those
whose money they are also charged with managing.
Without it, the supposedly back box systematic
and quant-based strategies may actually be rather more
illuminating, predictable and transparent than the
vagaries of what is going on inside a managers head.