The worldwide financial marketplace has changed dramatically over the past few years. The old "buy and hold" mentality of traditional financial planning is being questioned, interest rates are close to 0%, and many alternative investments like hedge funds have become highly correlated to stock and bond markets. I recently blogged that an astounding 67% of all hedge funds in the industry have less than 2 years of returns under their belt, and under $25 million in Assets. Funds with less than $25 million after two years have a high probability of going out of business shortly thereafter, making it important to have a defined investment strategy when choosing hedge funds.
I recently wrote about Neal Berger, a friend, who represents some of the wealthiest families in the world and also runs a niche fund of funds, Eagle's View Asset Management with a rare, yet highly valuable strategy which only allocates capital to niche hedge fund strategies. Neal wrote an extensive commentary last month about his philosophy of hedge fund investing, I'm happy that he's allowed me to reprint it here with some minor edits.
2009 WAS A GOVERNMENT ENGINEERED "FUGAZY" MARKET
Definition: "Fugazy" is a New York originated slang term for something that is not authentic. Johnny Depp uses this word in the 1997 film Donnie Brasco. The phrase is often used as a slang term to describe non-authentic diamonds or gemstones.
Dear Partners/Friends,
Our businesses have grown markedly over the past year and we attribute this to our investment performance as well as our posture in seeking strategies and Managers who exploit specific market inefficiencies or 'edge' without regard to the overall direction of risk assets. Increasingly, investors have come to realize that the hedge fund industry, in aggregate, is largely saturated with institutional capital and thusly, has essentially become a proxy for the overall direction of risk assets. We have found outstanding opportunities in 'niche-oriented' strategies where the demand/supply equation for inefficiency provides fertile ground for profitability. Specifically, across our Advisory and Fund businesses, we are currently invested in 18 different hedge funds across 16 different strategies as follows:
* Multi-strategy Arbitrage
* Treasury Bill Arbitrage
* Option Market Making
* Option volatility Arbitrage
* Matched Book Securities Lending (Stock Loan Financing)
* Statistical Arbitrage
* Quantitative Global Macro
* Electricity Trading
* Specialty Financing
* Trade Claims
* Relative Value Credit
* Foreign Exchange Trading
* Short-term high frequency trading
* Carbon emissions trading
* Deep value fundamental (for specific client needs/requests)
* Opportunistic Asia (for specific client needs/requests)
Despite my background as a Global Macro trader for more than a dozen years, we rarely make any substantive comments on the macro-economic landscape and/or market environment. Furthermore, we do not utilize a macro 'outlook' in the same manner as other investors often do. As mentioned previously, we merely seek to exploit market inefficiencies based upon market activity rather than a specific directional outlook for the market. We simply utilize our longer-term Macro view to determine if we want to be postured with or without any directional exposure to risk assets. In short, the answer to that question continues to remain firmly 'no'.
With that said, our current view is that 2009 was a government induced "fugazy" market. In short, a dead man could rise from his grave if provided with the amount of stimulus injected into the market through worldwide government intervention. We view 2008 as a manifestation of the true underlying condition of the economy which is rife with structural issues (continually reinforced poor attitudes toward risk-taking, reliance upon short-term compensation programs, permitting companies/entities to hold the balance of power by becoming 'too big to fail', and numerous other long-term structural problems plaguing the markets and risk-taking attitudes).
As government intervention has slowed/stopped toward mid-2010, we are once again witnessing a return to more natural market conditions whereby there exists a complete lack of appetite on the part of the private sector to hold risk assets given the disarray in the economy and markets.
Anecdotally, living in the New York City area, I have noticed an alarming trend. It goes without saying that a drive through local suburban NYC areas will highlight a shocking amount of "For Sale" signs on homes. More recently, however, these same private family homes have now turned their "For Sale" signs into "For Rent" signs. I have lived in this area for almost my entire life and I have not witnessed a situation whereby I've seen such a number of private homes being offered For Rent rather than For Sale. This tells me that homeowners are becoming increasingly desperate to generate cash flow from their properties either to stave off foreclosure or to generate any income whatsoever to cover basic overhead costs.
One major impetus of this letter is based upon the fact that we feel strongly that the time to divest from directional exposure to 'risk assets' is upon us. Obviously, this begs the question, what else can I do with my capital? Naturally, my bias is toward the strategies deployed by Eagle's View which seek to capture market inefficiencies regardless of the overall direction of risk assets. We do not make bets against the market, rather, we merely seek to avoid exposure to the direction of risk assets during periods where we feel a defensive posture is warranted. Furthermore, our outlook is long-term in nature and it is unlikely to change for an extended period of time. We believe the structural problems inherent in the global economies and financial markets will take many years and not merely months to resolve. No question, the market will have pockets of rallies and sell-offs. However, the fact remains, the market in aggregate has not risen for a period of more than 11 years now and we have no reason to expect this to change anytime in the near future.
On a slightly different topic, I was recently asked by a client to comment on the New York Times story regarding the massive redemptions and poor performance experienced by quantitative hedge funds in recent years (see: New York Times, Aug. 19, 2010). I excerpt part of my response as follows:
"The article is not surprising and has no real impact upon my personal thoughts regarding
any of the Funds in which we are invested. By definition, quant funds are trying to capture market inefficiencies. This requires that the demand/supply equation for these inefficiencies remain favorable enough for the quants to profit. As quant funds (and all hedge funds) have grown, the demand/supply equation between 'smart money' (edge takers) and 'dumb money' (edge providers) has created a situation whereby it is increasingly difficult to capture inefficiencies for larger hedge funds pursuing the same strategies. This is precisely why we have gravitated toward more 'niche-oriented' managers who operate in less saturated corners of the marketplace(s).
If the hedge funds are the Remora fish feeding off of the scraps of food generated by the Whales (the mutual funds, public investors, etc.), by definition, the Remora fish need to be smaller than the Whales who are throwing off those bits of meat. Certain quant strategies and Managers have themselves become the Whales. The hedge fund industry at large is saturated with too much capital chasing too few inefficiencies (see Stanley Druckenmiller retires yesterday). It has largely become a proxy for the equity market or the direction of risk assets. This is precisely why we've been doing what we've been doing for the past few years in seeking to invest in 'niche' strategies where the demand/supply equation for 'edge' is still favorable. Not all quant
strategies are created equal. The article is referring to the larger, mainstream type quant strategies. Not the type of strategies that we are invested in."
Client response:
"Thanks - these are good insights. The other issue with quants seems to be that the markets haven't been behaving according to model over the last 2 years. If some are retooling their
models in a drastic way, that could make it a dangerous time to invest."
My final response:
"While I agree that this may be a dangerous time to own risk assets, the risk of a short-term ‘crash’ in the markets has actually diminished over the past years in my opinion. This does not mean that markets cannot fall substantially, however, I believe they may do so in an orderly manner. I would argue that the markets haven't been behaving 'according to model' (or in accordance with the laws of physics) for more than the last 2 years+ as a direct result of the proliferation of quantitative, high volume/high frequency models, as well as active government intervention. This is one major reason why I left trading years ago."
That said, the models are very diverse and there is largely no collusive efforts amongst the various players. As a result, there is substantial, yet chaotic, 2 way flow in the market. Ironically, in my opinion, this actually makes the market safer and less prone to a short-term ‘crash’ (witness the market snap back on May 6, or the relatively 'orderly' decline of 2008).
I personally don't fear the markets, ironically, even as the short-term chaos (random noise) increases. It is only when everyone is going the same way, or assumes truisms that aren't actually correct, that the market is most dangerous in my opinion. Confusion and 2-way flow actually make the market safer in my opinion due to the fact that there is always a short seller looking to buy as markets fall and a long looking to sell as the market rallies. Perversely, this acts as a short-term buffer to the market.
The markets will always be around. Adapt or die as they say.
The need for hedge fund expertise has never been more apparent. Our Principal has been investing in hedge funds for more than a dozen years both personally and on behalf of high-net worth clients. We remain ever vigilant to matters of due diligence. We conduct a thorough review of Auditors, third-party administrators, and stated performance results in the context of the strategy and market environment. This is in addition to the many other aspects of our due diligence process.
Eagle’s View offers a very unique and attractive product. We provide customized hedge fund advisory to high-net worth families and individuals. We create bespoke portfolios for investors based upon return expectations, tolerance for risk/volatility, and liquidity needs. We are actively raising assets for our 'niche' Fund of Funds product (both onshore and offshore) with a $1 Million minimum. As to our Advisory product, we are accepting new clients at this time at a $5 Million minimum.
My door is always open for questions, comments, referrals, and/or parties interested in our services. Feel free to pass along this letter along to any investors or other parties who you feel may find this of interest.
Warm Regards,
Neal
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