Funds Hub
Money managers under the microscope
LIPPER: Equine vs equity investing
Is betting on horses very different from picking stocks? Can understanding a gambler’s approach and mentality give a better understanding of fund managers?
In searching for answers to these questions, I spoke to Paul Moulton, a professional gambler who originally worked in the fund management industry. He then set up a fund research company (Fitzrovia International, which he eventually sold to Reuters), although his working life began with an attempt to become a professional chess player.
Most of the fraternity of professional gamblers who make a living from horse racing are what Moulton describes as ‘traders’ or ‘chisellers’.
This group do not really look at horses at all, but look at market movements, hedging back their bets, and aiming to make tiny but regular profits with much less risk. They remain tucked away in their homes in front of an array of computer screens.
Moulton sees himself as part of a second, smaller group of professional punters, those he refers to as ‘judges’, some of whom look at horses in the paddock to assess their physical condition and thus their chances, while others are more reliant on assessing form based on previous races.
Some of them may even be conscious of the FSA’s warnings on funds’ past performance, which is deemed to be no guide to future returns. Although past performance does tend to shorten a horse’s starting price.
As part of this approach, Moulton has gathered vast amounts of data on all aspects of racing (jockeys, trainers, pedigrees, speed figures and so on) in a database that covers all horses in all races in the UK and Ireland since January 2005.
Risk Management: Did fund managers learn their lesson?
By Detlef Glow, Head of EMEA Research at Lipper. The views expressed are his own.
In the last decade investors and fund managers faced two major crises in the stock markets, the popping of the technology bubble in 2001 and financial crisis starting in 2006.
Portfolio managers suffered average losses of about 50 percent in the wake of both crises, leading investors to question what their fund managers learned.
A Lipper and Avana Invest study on the maximum drawdown of actively managed funds found that those fund managers must have introduced new risk management tools after the bust of the technology bubble. Still, they failed to meet investor expectations on managing risk.
The changes led to smaller tracking errors, but the funds suffered nearly the same losses shown in their respective markets during the 2006-2010 financial crisis.
The study by Lipper and Avana, a German asset management boutique firm, found that portfolio managers started a risk management system that measured relative risk compared to their benchmarks instead of measuring absolute risk in terms of losses.
The new management guidelines did not meet the expectations of private investors and led to the following conclusions: Relative risk management systems are penalizing fund managers if their risk compared to the benchmark moved above a defined level. The study found that a fund manager was not allowed to hold a high percentage of his portfolio in cash or decrease the weighting of a specific industry to zero, as this would increase the risk of the portfolio relative to the benchmark.
Hedge funds vs mutual funds
By Dunny P. Moonesawmy, Head of Fund Research for Lipper in western Europe, Middle East and Africa. The views expressed are his own.
Hedge funds took some heat from the credit crisis as liquidity and transparency became critical factors in investment decision-making. It’s fair to say hedge funds continued to deliver decent returns to investors, but how do they compare to mutual funds if we focus on performance and risk alone?
In 2008, the average return for mutual funds stood at a negative 22.91 percent. At the same time, hedge funds posted average returns of minus 8.37 percent. We might have expected a stronger rebound for mutual funds in 2009 and 2010 than for hedge funds, yet the data shows better average returns for hedge funds in both years. Positive returns in the sector stood at 22.36 percent and 18.08 percent respectively against 21.16 percent and 10.23 percent for mutual funds.
If we look at performance over a longer time frame, mutual funds posted annualized returns of 2.07 percent over 3 years and 1.85 percent over 10 years while hedge funds recorded returns of 8.81 percent and 3.77 percent respectively.
We have a different story on the risk side. Part of the appeal of hedge funds is that they seek to actively manage volatility, but managers struggled to keep volatility under control during the credit crisis. The 3-year annualized standard deviation was higher than mutual funds (19.19 percent against 16.65 percent) and the 10-year figures showed similar results (16.80 percent against 12.44 percent).
If we go deeper into the data, we can note that volatility is strongly linked to the asset class for mutual funds while at the same time performance and volatility are positively correlated. As a simple example, a bond category will tend to have lower volatility and lower performance than an equity category. And likewise, an aggressive diversified fund will likely to have higher performance and volatility than a conservative diversified fund.
To view a graphic of the performance data, click on this link.
Risk revolution
By Dunny P. Moonesawmy, Head of Fund Research for Lipper in western Europe, Middle East and Africa. The views expressed are his own.
The evaluation of an investment is measured by its potential performance and risk, and historically, investors have given more importance to the former than the latter. Recent events in the market, however, have challenged the hierarchy, placing risk at the heart of investors’ thinking. It is little short of a revolution in the investment industry.
While performance is associated with opportunities, risk is linked with danger and the switch in thinking is prompting investors to take a more defensive approach.
There have been several factors behind that change. The market is more volatile and given to quicker and more abrupt downturns; there is a polarization of economic growth outside core western economies; demographic change has led to the growing importance of liability management; and regulatory constraints have put extra pressure on institutional players to limit risky investments.
Up to 1996, we enjoyed smooth growth trends in markets, with steady periods of drawdown and recovery. Over the past 15 years, however, the nature of market cycles has changed.
Periods of exponential growth have been followed by deep crises, creating opportunities for hedge-fund style managers but a nightmare for long-only managers trying to protect assets. Both institutional and retail investors have had a hard time during these two crises with significant consequences on their risk appetite. For a chart detailing the recent trends, click: http://r.reuters.com/gef88r
Data from Lipper shows 10.18 percent average annual growth of the MSCI World TR in dollar terms between 1970 and 1980, 16.3 percent the following decade and 15.92 percent in the 1990s. The figure stood at only 1.77 percent during the last decade due to the two major downturns — the bursting of the internet bubble and the credit crisis.
Where pension funds went wrong
Knut Kjaer, adviser to some of the world’s biggest asset pools, and former head of Norway’s government pension fund, told pension funds some home truths at the CFA Institute’s European Investment Conference on Tuesday.
Kjaer said the financial crisis had exposed two main pitfalls in institutional investment – the tendency to run with the herd, and the adoption of overly complex portfolios.
He was especially critical of investors who had made an allocation to hedge funds or private equity as a form of diversification without properly thinking through the implications for overall risk levels. He pointed out that some so-called diversified portfolios had performed very badly during the financial crisis.
So what is a poor pension trustee to do? Kjaer said they needed to construct portfolios that differentiated better between alpha and what is just costly beta: “Particularly in alternative assets you see a lot of beta dressed up as alpha.”
He also suggested pension funds should think about reducing the overall risk they are taking. Pension funds tend to set the risk level too high in good times, blame the asset manager when things go wrong, and then downscale the risk at the worst possible time.
Kjaer believes pension funds need a more disciplined risk framework with decision rules that enforce regular rebalancing to top-slice frothy assets and buy undervalued assets.
“This prevents the assets with the highest drift from dominating the portfolio and gives you an automatic value bias,” said Kjaer. “It also prevents you entering markets where the upside is small in comparison to the downside.”
Morning line-up
Hedge fund stories from the past 24 hours from Reuters and elsewhere:
Renaissance CEO Simons to retire – Reuters
‘Cruz missile’ returns with a hedge fund – WSJ
Swiss bank fund of funds adds Harvard chief risk officer – Finalternatives
Banks offering credit again in hedge fund land grab – Reuters
Morning line-up
Hedge fund stories from Reuters and elsewhere:
New players spur hedge fund secondary market – MarketWatch
Hedge funds got it right – Washington Post
Arbs say Cadbury price hopes overblown – Reuters
Hedge funds remain defensive – Seeking Alpha
Pessimists pay the price – WSJ
Isabella of Castile – the hedge fund manager
Isabella of Castile was a controversial woman. A woman who made history for herself and her country. She has been called saint and a tyrant, but never before a hedge fund manager.
Fred Fruitman, managing director of Loeb Partners Corp., the family office that oversees the Loeb family fortune, took care to bridge that gap.
He told delegates of the Asset Allocation Summit Europe 2009 this week that Isabella, a Renaissance woman, could have taught XXI century hedge funds a thing or two. An eye for opportunity, drive for returns, and a controversial reputation were also a trade-mark for both Isabella and hedge fund managers.
Take Isabella; a woman of self-belief and vision. Or, a fanatic who did not rest until she chased all the Moors out of Spain, took their riches and created the framework for the Spanish Inquisition.
That’s Isabella, depending who you are talking to.
Despite being described by some as parasites, hedge funds have been also credited for exploiting the inefficiencies of the financial system and — in so doing helping it tick along.
Unlike Isabella they did not discover continents or invade countries, but some say some countries have been left wobbly after hedge funds had finished with their currencies.
Morning line-up
Hedge fund stories from the past 24 hours from Reuters and elsewhere:
How hedge funds are managing risk – Seeking Alpha
Citadel to meet all 2008 redemptions this year – Reuters
Penthouse of indicted Hedgie sells for $3.3mln – Palm Beach Daily News
Who raised the risk budget?
There’s been much debate about recent prop trading profits at banks including Goldman Sachs, JP Morgan and others in the first half of the year, but one important question remains unasked.
How, just over half a year after some market observers pronounced prop trading perpetually and eternally dead, did the prop desk at these banks bounce back to life in a fashion that would have turned Lazarus green with envy?
After all, after taking huge writedowns on subprime securities, many of them directly attributable to their prop desks, throughout the financial crisis, a large number of the chastened banks slashed their prop desk staff and put strict risk limits on trading.
But while the financial crisis was still in full swing, someone raised the risk budget.
