The Triumphs, And Obsession, Of New Hedge Fund Managers
The New York Times
May 12, 2006
Insider
May 12, 2006
Insider
By JENNY ANDERSON
SIZE matters in hedge funds. But bigger is not always better.
New fund managers tend to knock the cover off the ball during their first two years, accounting for much of the outperformance that has made hedge funds famous, a new study has found.
From Jan. 1, 2004, through Dec. 31, 2005, 167 "emerging managers" — those who started funds in 2003 and had $30 million to $250 million in assets — outperformed two leading hedge fund indexes, according to a study written by Sam Kischner and Ron Panzier for Mayer & Hoffman Capital Advisors, a fund of hedge funds based in New York that invests in the funds of emerging managers.
The new kids on the block had a return of 22.03 percent, on an equal-weighted basis, beating the Morgan Stanley Capital International noninvestable equal-weighted hedge fund index, on a total return basis, by more than 45 percent and more than double the returns of the Credit Suisse/Tremont investable index, the best-performing hedge fund index for the two-year period.
Of course, it is easier to post big gains when working from smaller numbers. But another reason the fresh faces start with a bang may be entrepreneurial angst.
New managers "live, eat, sleep and breathe their positions in their first year," said Matthew Hoffman, chief investment officer of Meyers & Hoffman, at the MAR/Hedge conference in San Francisco. "When they are building a business, they are very conscious about every position in the portfolio."
There has been research trying to determine if new managers outperformed more established ones. Some studies conclude that new managers outperform their established peers in their first three years, or at least beat those managers included in the indexes used to measure the industry. (The indexes, however, rarely include the investing giants.)
This creates built-in tensions for hedge fund investors: how to evaluate properly a manager with little or no track record.
Complicating the picture is the lure of fees. Hedge fund managers are always quick to point out that mutual funds are principally paid to gather assets because they receive a paltry percentage of the assets under management. Hedge funds, they would argue, are paid — and paid extremely well — for performance.
This is, of course, only half-true. Because hedge funds can command 2 percent of assets as a management fee and 20 percent of profits these days, gathering large pools of assets translates into steady, hefty compensation. Hedge fund investors run the risk of managers' becoming more interested in not losing fee-generating money than making pots of it on risky, and potentially profitable, investment ideas.
At the MAR/Hedge conference, a panelist who invests in the funds of emerging managers said that he had seen a successful team of managers self-destruct not because of investment ideas but because they were preoccupied with "empire building" rather than investing.
That was not the norm, according to the Mayer & Hoffman research.
According to the study, the class of 2003, or the 167 managers measured on an equal-weighted basis, returned 11.39 percent in 2004, compared with the MSCI equal-weighted index, at 6.55 percent, and the Credit Suisse/Tremont investable index, at 5.31 percent.
In 2005, again on an equal-weighted basis, they delivered returns of 9.55 percent, compared with 8.20 percent for the MSCI hedge fund index and 3.60 percent for the Credit Suisse/Tremont index.
Skeptics will point out that not all new managers survive, creating a bias toward the returns of those who do. Hedge fund investing, among the most Darwinian of investment disciplines, is at its core a simple science: perform well and assets flood in; perform poorly, investors redeem their money and if enough is redeemed, the fund closes. It is generally accepted that the average hedge fund life is only 2.7 years.
According to the Mayer & Hoffman study, 2 of the 167 funds closed at the end of 2004 and by the end of 2005, 12 more had shut down. The total failure rate was 8.4 percent, mirroring the business's median attrition rate for the year of 8.1 percent, according to four hedge fund indexes.
Of course, if everyone bets on the new kids, the funds will grow wildly, and any performance as a result of size will be whittled out. There have been an unusually high number of hedge funds starting off with more than $1 billion, begging the question of how new managers are going to learn to manage a business while immediately having to run a huge portfolio.
Fortunately, not all the investors are the same. Pension funds who may want less risk and high single-digit returns can gravitate toward more institutional businesses whose return outlooks may not be what they were when the managers' portfolios were smaller and nimbler. These investors may be more focused on minimizing risk in a portfolio than maximizing returns.
But for those seeking big returns, they can gamble on the new managers. After all, the hedge fund universe used to be dominated by big egos, big bets and big returns. Let's see if the new egos can take their place.
SIZE matters in hedge funds. But bigger is not always better.
New fund managers tend to knock the cover off the ball during their first two years, accounting for much of the outperformance that has made hedge funds famous, a new study has found.
From Jan. 1, 2004, through Dec. 31, 2005, 167 "emerging managers" — those who started funds in 2003 and had $30 million to $250 million in assets — outperformed two leading hedge fund indexes, according to a study written by Sam Kischner and Ron Panzier for Mayer & Hoffman Capital Advisors, a fund of hedge funds based in New York that invests in the funds of emerging managers.
The new kids on the block had a return of 22.03 percent, on an equal-weighted basis, beating the Morgan Stanley Capital International noninvestable equal-weighted hedge fund index, on a total return basis, by more than 45 percent and more than double the returns of the Credit Suisse/Tremont investable index, the best-performing hedge fund index for the two-year period.
Of course, it is easier to post big gains when working from smaller numbers. But another reason the fresh faces start with a bang may be entrepreneurial angst.
New managers "live, eat, sleep and breathe their positions in their first year," said Matthew Hoffman, chief investment officer of Meyers & Hoffman, at the MAR/Hedge conference in San Francisco. "When they are building a business, they are very conscious about every position in the portfolio."
There has been research trying to determine if new managers outperformed more established ones. Some studies conclude that new managers outperform their established peers in their first three years, or at least beat those managers included in the indexes used to measure the industry. (The indexes, however, rarely include the investing giants.)
This creates built-in tensions for hedge fund investors: how to evaluate properly a manager with little or no track record.
Complicating the picture is the lure of fees. Hedge fund managers are always quick to point out that mutual funds are principally paid to gather assets because they receive a paltry percentage of the assets under management. Hedge funds, they would argue, are paid — and paid extremely well — for performance.
This is, of course, only half-true. Because hedge funds can command 2 percent of assets as a management fee and 20 percent of profits these days, gathering large pools of assets translates into steady, hefty compensation. Hedge fund investors run the risk of managers' becoming more interested in not losing fee-generating money than making pots of it on risky, and potentially profitable, investment ideas.
At the MAR/Hedge conference, a panelist who invests in the funds of emerging managers said that he had seen a successful team of managers self-destruct not because of investment ideas but because they were preoccupied with "empire building" rather than investing.
That was not the norm, according to the Mayer & Hoffman research.
According to the study, the class of 2003, or the 167 managers measured on an equal-weighted basis, returned 11.39 percent in 2004, compared with the MSCI equal-weighted index, at 6.55 percent, and the Credit Suisse/Tremont investable index, at 5.31 percent.
In 2005, again on an equal-weighted basis, they delivered returns of 9.55 percent, compared with 8.20 percent for the MSCI hedge fund index and 3.60 percent for the Credit Suisse/Tremont index.
Skeptics will point out that not all new managers survive, creating a bias toward the returns of those who do. Hedge fund investing, among the most Darwinian of investment disciplines, is at its core a simple science: perform well and assets flood in; perform poorly, investors redeem their money and if enough is redeemed, the fund closes. It is generally accepted that the average hedge fund life is only 2.7 years.
According to the Mayer & Hoffman study, 2 of the 167 funds closed at the end of 2004 and by the end of 2005, 12 more had shut down. The total failure rate was 8.4 percent, mirroring the business's median attrition rate for the year of 8.1 percent, according to four hedge fund indexes.
Of course, if everyone bets on the new kids, the funds will grow wildly, and any performance as a result of size will be whittled out. There have been an unusually high number of hedge funds starting off with more than $1 billion, begging the question of how new managers are going to learn to manage a business while immediately having to run a huge portfolio.
Fortunately, not all the investors are the same. Pension funds who may want less risk and high single-digit returns can gravitate toward more institutional businesses whose return outlooks may not be what they were when the managers' portfolios were smaller and nimbler. These investors may be more focused on minimizing risk in a portfolio than maximizing returns.
But for those seeking big returns, they can gamble on the new managers. After all, the hedge fund universe used to be dominated by big egos, big bets and big returns. Let's see if the new egos can take their place.
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