Buyer Beware – Cavit his Erupter?


Cavit his erupter
Peter: (about Greg selling his car) “He said he was gonna really cavit the guy’s erupter!”
Carol: “Cavit his erupter?”
Mike: “I think he means caveat emptor.”
And that is how I learned of the “buyer beware” concept. Or perhaps to put it in a less nefarious-sounding way, “know what you’re buying.” Too often in this industry we witness investors piling into a strategy because of recent performance or, let’s say 2008 for example, without understanding what they’re getting or conducting anything close to meaningful due diligence. The result, for all involved, is often performance-mean reversion or performance that is outside of unsupported expectations, leading to asset outflows. As Ignites recently reported, Mainstay’s Marketfield Fund has been the poster child of what happens when “weak money” (as Morningstar’s Josh Charney put it) is thrown at a fund. The article posits that this will have a negative impact on allocations to liquid alternatives more generally, which would be unfortunate.

Most true alternative strategies – not REITs, not MLPs, not BDCs – are intended to help shape the risk profile of a total portfolio and add sources of uncorrelated alpha. They aren’t meant to keep up in bull markets and they can’t be expected to deliver stellar returns across all market environments. In fact, whether traditional or alternative, the best money managers and the best strategies should be expected to have a bad quarter, a bad year, a bad three-year period. Poor short-term performance on the surface says nothing about the efficacy of a manager or strategy. The key question investors must ask, is whether or not the investment thesis has changed since capital was initially allocated? Has the ownership structure changed? Has the investment team changed? Has the alignment of interests changed? Has the strategy changed? Has the business of asset gathering gotten in the way of alpha generation? Of course, one has to have understood these points initially in order to determine if they have “changed.” As David Swensen of Yale’s endowment said, “Casual commitments invite casual reversals.” Don’t invest casually. Ask us (and your other managers for that matter) the hard questions, so that when performance inevitably turns south for a time, you know how to accurately gauge the situation.

Liquid Alts Corner
The Data

Data as of May 31, 2015

All major alternative categories produced positive, though somewhat muted, returns in May. Long/short equity had the strongest performance, earning just under 1%, bringing the year-to-date return to about 2.1%. Managed futures continues to be the best performer this year and over the last 12 months, earning 2.7% and 13.5%, respectively. However, on a longer-term basis, managed futures funds are still lagging the primary liquid alternatives categories, earning just 1.7% annually over the last three years. Long/short equity on the other hand has earned nearly 8% per year, while multialternative funds have gained almost 5% annually.


Data as of May 31, 2015

Flows into equity market neutral, long/short credit and long/short equity were nearly flat during May, while managed futures funds brought in roughly $500 million and multialternative funds saw nearly $2 billion in net inflows. At the fund level, flows were spread out with no single manager dominating either category. Year-to-date, managed futures and multialternative are the only strategies with positive flows, bringing in $3.6 billion and $6.2 billion respectively.

Wirehouses Continue to Increase Alternative Investments
Despite headwinds such as modest performance during a strong equity market, a new study from Money Management Institute reports that wirehouse-associated alternatives increased by more than $30 billion during 2014. Much of that growth happened in the liquid alternatives space, which increased from $88 billion to $102 billion from 2013 to 2014. This is more than twice the industry growth rate of 7.3%. While we are sometimes quick to point out when we don’t think investors are quite getting it, it is always heartening to see that there are those who, despite market forces, appear to be doing what’s best for the end client.

Hedge Funds In The News

Market Volatility? – Blame Computer-Driven Hedge Funds of Course!
While there have certainly been instances of computer-driven algorithms causing short-term market volatility, these are very rare when compared to true drivers of uncertainty such as slowing economic growth, rising rates, Greece, ISIS, Russia, wars, rumors of wars, earthquakes, floods, Janet Yellen’s mood or even fundamentally based traders. So why the headline “Market Volatility Could Be Exacerbated by Computer Driven Hedge Funds”?
Clicks of course…

Paulson Donates $400 Million to Harvard
Despite mixed results for his investors in recent years, John Paulson was able to make a $400 million gift to Harvard’s engineering school that earned him the right to name the building, which is being called the John A. Paulson School of Engineering and Applied Sciences. Interestingly, despite having received many large gifts while building the school’s massive endowment, only three other people have had buildings named after them. The list includes John Harvard, John F. Kennedy and T.H. Chan.


Meredith Whitney Shuts Her Hedge Fund
From The Wall Street Journal
Meredith Whitney shut her fledgling hedge fund, a setback for the ex-banking analyst who became one of Wall Street’s highest-profile women during the last financial crisis but ran into challenges in recent years.

The hedge fund was launched in 2013 from Bermuda, where Ms. Whitney owned a home in the exclusive Mid Ocean Club. London hedge-fund giant BlueCrest Capital Management LLP agreed to provide her with $50 million to start the fund. But in October 2014, BlueCrest asked to redeem its investment, and Ms. Whitney refused, citing contractual agreements. BlueCrest sued to get its money back, pointing out in a court filing that the fund was down 12% in the first 11 months of 2014.

Stanley Arkin, Ms. Whitney’s attorney, said the BlueCrest lawsuit has been resolved and all remaining money returned to external investors as of the end of May. He added that he expects her to start a new venture because “she’s one of the most extraordinary professionals in the securities industry, and a talent that will go on and on.” This is as per Naegeli USA Court Reporters.

Education
Matt Dority, a partner at QES LLC, recently had a thoughtful write-up regarding the value added (or lack thereof) of volatility targeting by managed futures funds. While volatility targeting is widespread within the managed futures space, Mr. Dority points out several problems with the practice. First, exposures are almost always off target as past volatility does not necessarily correlate with future volatility. Because of this, exposures can grow arbitrarily large when market volatilities decline, leading to severely magnified risk (see the Swiss Franc in January). Finally, a strategy that tends to have “crisis alpha” but reduces exposure as volatility increases while a crisis unfolds leaves “alpha” on the table. The piece is certainly worth some reflection for investors attempting to navigate the managed futures space.

Click here to read more about Utilizing Managed Futures Strategies

And Lastly…
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