Perhaps the biggest piece of Hedge Fund news in the last few months has been that of the New York City Employees Retirement System bowing out of Hedge Funds. In a move that echoed that of Calpers last year and several smaller public pensions in the US, NYCERS is certainly a blow for the likes of Brewin and D.E. Shaw who managed money for the plan but moreover, for the industry as a whole. Of course, the headlines are far more damaging than the loss of $40m or so in management fees the industry reaped from this retirement system.
The prepared statements of Letitia James, New York City’s Public Advocate seemed very politically charged. In a now famous statement, Letitia chided: “let them sell their summer homes and jets”, charging managers to return fees to investors. This is, of course, a brilliant sound bite which the wider financial press used to great effect in damming Hedge Funds’ prospects. It is difficult however to not see a deeper, more emotive under tone to James’ statements. If, as she has constantly maintains, the move away from Hedge Funds is one of rationality and logic and due to the retirement system feeling that the requisites of outperformance and downside protection were not met, one would expect a statement reflecting such reasoned opinions and not this attack on the perceived high salaries of managers. An anecdotal assessment of managers in the wider industry and analysis of the tide of change in regulation draws the very quick conclusion that costs and fees are being pushed down. Investor demand is clear in this regard, 2:20 fee models are becoming a thing of the past. Perhaps if NYCERS had sought opportunities with smaller, nimble managers that offer more competitive fee structures rather than the much larger and more cumbersome hedge fund shops with whom the overwhelming majority of hedge fund assets in were invested, her opinion and portfolio performance may be drastically different.
Indeed, 2016 seems to be a year where investors are once again assessing the opportunity that smaller managers can offer. Large players like Albourne as well as new funds of funds managers dedicated to boutique shops are catering for institutional investors’ wants to put money to work in this space, chasing the compelling returns that can be found here. The dominance of larger Hedge Fund managers have forced boutique managers to source different, often more resilient opportunities as well as offering more competitive fees. Is the NYCERS move one that reflects the wider institutional inability to assess opportunities across the Hedge Fund market? It is certainly true that less constrained endowments, Harvard and Brown to name two, have done much better with their hedge fund portfolio and this must surely be connected to their policy of casting a wider net, screening managers of all strategies and sizes.
But what if this move could be seem as indicative to wider sentiment in the Hedge Fund world? Hedge Funds accounted for 2.8% of the NYCERS portfolio in 2015 and $1.7bn of a wider $8bn in Alternative Investments. Little has been reported on the other parts of the alternatives portfolio for NYCERS but their silence could be indicative that they share a view that is gaining ground amongst investors that funds which exploit more opportunities that lie outside of liquid markets are the best way to insulate portfolios and achieve outperformance. Do the growing amount of hedge funds in the market mean that the opportunities and inefficiencies that hedge funds seek are becoming more efficiently priced? Eugene Fama famously proved that in the long run and on aggregate markets are efficient, for many years the hedge fund industry has, through existence, refuted this claim but with so many hedge fund actors in the market viewing markets through a similar prism, seeking the same trades and opportunities, logically, fewer mis-priced opportunities would exist. Certainly, this opinion is not news to some of the most astute investors who have used simple index funds in the most efficient markets for decades and whom, instead of seeking large funds in developed markets, write expense forms to places like Iran and Iraq, their investors have been much better off for it.
The hedge fund world is diverse, this article has purposely not quoted industry aggregate figures to try to make a point about industry wide performance due to this diversity. There is still strong belief that the hedge fund sector can deliver out performance and downside protection, many institutional portfolios stand as proof of this fact. What is less simple, though, is how to choose a good manager and unfortunately, an assessment of large, institutional friendly players will not suffice if you are looking for lean operations and value for money. Tish James might do better to look to her own team, investment guidance and due diligence processes before damning the whole industry.
Written by George Lane.