Hedge funds charge too much and deliver too little. That’s a familiar — and admittedly changing — verdict from investors. But here’s a not-so-well-known fact: many of the largest and elite hedge funds have been missing from the numbers many institutions use to reach their conclusions.
That’s because hedge funds voluntarily report their metrics to commercial databases — and many funds are reluctant to share information that may be sold to competitors.
In a live podcast recording of
In Conversation with Julie Segal at the Allocators’ Choice Awards Roundtable in late September, I interviewed Paul Zummo, CIO of J.P. Morgan Alternative Asset Management, and Jon Caplis, CEO of hedge fund research firm PivotalPath, about the hole in the data investors use to determine whether hedge funds are worth it and other practices that can distort how much money they put into everything from relative value funds and credit to multi-strats.
The good news, Zummo says, is that investors that are less bound by rigid investment policies, such as family offices and sovereign funds, have been increasingly allocating to hedge funds over the past few years.
These bullish-on-hedge-fund investors have been upending their asset allocation assumptions: plugging in higher expected returns and alpha and lower volatility and correlation with markets into their models. “If returns go up by a percent and a half and beta actually is zero… and vol comes down a bit, that’s going to look a lot better in an optimizer,” says Zummo.
But pension funds and other more traditional institutions have been lagging. These investors have far less flexibility in how they divvy up their portfolios (and there are plenty of good governance reasons to do that) and end up baking “flawed” hedge fund data into these influential capital market assumptions that determine their asset allocation.
Another problem Zummo points out is the widespread and wrongheaded assumption that hedge funds are somehow one asset class. Investors look at aggregated numbers on the entire industry to form their views, masking (After listening to these two guys, I’d say burying) what’s happening with individual strategies or managers. Listen to the whole podcast to hear Zummo’s colorful — and elucidating, at least to me — description of the limits on thinking in averages. (And learn his favorite restaurants.)
Even as investors continue to debate if hedge funds are worth it, Caplis pointed out other material changes in the industry. For one, labels that managers slap on funds don’t mean quite as much as they once did.
Macro managers are building out equity books, quants are developing fundamental research, and multi-strategy funds are becoming some of the biggest allocators to outside managers. “There was a time where they were the ones that were really finding these emerging portfolio managers, swallowing them up,” says Caplis. Investors could only get access to the best talent through a fund. The biggest trend to watch, he adds, is the use of separately managed accounts and how they’re changing the equation to find the next best investor.
So back to the original question. Caplis says PivotalPath’s Relative Value Index, which focuses on strategies that are designed to be uncorrelated with the market.
Caplis says over the last three years, the index generated annualized returns of about 9 percent and alpha of about 6.5 percent per year. The index includes roughly 200 funds representing $600 billion in assets.
That means investors can put that 6.5 percent into the model rather than the zero that some investors have been using for years. As Caplis says, “That’s the difference between being in hedge funds, and not being in hedge funds.”
Go ahead and listen to the whole thing. And give me your feedback and ideas for my next guests. Email me at
jsegal@institutionalinvestor.com.
More on some of the topics mentioned on the podcast:Everything Investors Know About Hedge Funds Is Based on Flawed DataA CIO’s view: Insights from 30 years of hedge fund investing photo