Is the glass half-full or half-empty?

Tue Jul 5, 2011

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“When you change the way you look at things, the things you look at change”

By Niki Natarajan

"When you change the way you look at things, the things you look at change," is the ancient Tao observation, as paraphrased by Dr Wayne Dyer. It could have just as easily been written to explain the shift in paradigm that is finally happening in hedge funds as it could to describe the optical illusion illustrated.

From the point of view of most hedge fund managers, they are simply managing money, actively, differently, but they are still asset managers. Somewhere this idea got lost in translation and most investors, except those truly enlightened, have been buying hedge funds as 'alternatives’ for the last 10 years.

As such these alternatives had their 5% or so allocation in institutional portfolios – and that, at least until the financial crisis, was that. Now that the world is emerging from the global fog and the debris has been assessed, some investors are saying alternatives are not alternatives – because in the end they were all correlated.

Are they awakening at last? Is there enlightenment in asset management? Investors now have a chance to change the way they look at things and perhaps actually change the fortunes of their investment portfolios. Equities, when managed in a long/short strategy or in any other style, are still equities. Knowing this is called awareness. And awareness is the first step towards transformation.

Customisation is this awareness in action. Some investors are now taking a look at their portfolios and deciding where they really want to go and over what period of time. They are starting to break down their alternative portfolios into the component parts: equity-based strategies; fixed income-based strategies; and the truly uncorrelated strategies, such as commodities and other real assets, have become the alternative 'bucket’.

This has been discussed at length over the last 10 years, but it seems that the correlations of 2008 and 2009 have now made this a real issue rather than a hedge fund marketing story.

Indeed, K2 Advisers – sub-adviser to the Dexion Equity Alternative fund – has revisited this paradigm shift. In its April investor letter, K2 likens this shift to "an advance in technology", such as Johann Gutenberg’s invention of the movable type printing press.

Hedge funds are now being seen as the advanced money-management tool they always were. In fact, such is the demand for pure-play products that Dexion Equity with K2 have re-jigged the fund’s mandate to be a concentrated US equity fund for just this reason (page 32).

Hedge fund assets are growing again, but the reason hordes of investors have not stampeded into hedge funds to boost their actively managed equity allocations is down to looking at this industry through old glasses.

They argue that the performance of the hedge fund industry, which is only up 1.74% for the year to date according to the HedgeFund Intelligence Composite, is the reason they are stalling. While I am not advocating the acceptance of lacklustre performance of any kind, what if the expectation hurdle needs to be reset in this new Aquarian age?

Prior to the crisis, investors were sold and expected 10%-plus returns a year from hedge funds – and this belief in outsized returns is why more investors bought hedge funds. Despite the "disappointing returns", this view of hedge funds as the performance Holy Grail still prevails in the minds of the misinformed. So no wonder investors are disappointed.

With most end-investors and their consultants managing future liabilities based on assumptions, one has to hope that the assumptions are correct. But, as everyone knows, "to assume is to make an ass of u and me".

So what if the real return is, for example, half of what pension funds are assuming in this near-zero interest rate environment? Compared with the returns of Japanese pensions after two decades of a similar environment, year-to-date hedge fund returns of 1.74% are maybe not looking too bad after all.

ISSN: 2151-1845 / CDC10004H

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