Chidem Kurdas
Some people made it their life’s work to seek exceptional money managers long before public pensions like CalPERS came to the hedge fund industry and they continue doing so now that CalPERS has announced it is getting out.
Outside the passive index investing world, identifying skilled managers remains the top objective, whether investing in hedge or mutual funds or some other vehicle. To get above-market returns, you need above-average skilled managers.
In the case of hedgies, picking the right ones is essential because performance is widely dispersed and more so in some strategies than others.
For the industry as a whole, BlackRock found that in the first half of 2014 top decile funds returned 11% while the bottom decile lost 5%. This is a slightly narrower disparity than a year ago but still “the key issue for investors in hedge funds remains identifying managers with the most skill,” as David Barenborg of BlackRock Alternative Advisors states.
The portion of return due to manager skill was almost 60% in some cases but varied across strategies.
Experienced investors spend time to investigate new or emerging managers because established ones with long records are not likely to provide the extra oomph. Chances are a manager with a 30-year-plus stellar record either charges high fees or is no longer interested in trading someone else’s money. George Soros manages his own fortune; the aim is to find the next boy Soros, as they say.
This is a tough and never-ending quest. On occasion the search ends in a debacle, like the Manhattan Capital story I tell in Ponzi Regulation—chapter 4.
In that case the young manager was smart and promising—he correctly called the late 1990s stock bubble several years before it crashed, during years when Federal Reserve officials claimed there was no way to know whether there was a bubble. He failed because he started short selling stocks too soon.
Another trap is mistaking market return – or beta – for skill. Many who did well last year benefitted from the boom. They may have no ability to generate above-market – alpha – return. Beta is cheap and easy to get via index funds.
Peter Urbani, KnowRisk Consulting, argues that emerging managers’ edge over established one is improving. Funds of funds, which provide seed capital to new managers, declined in the aftermath of the financial crisis. Mr. Urbani points out that funds of funds have finally stopped losing assets.
More capital will foster a larger pool of promising candidates, but whether that makes the selection any easier is not clear. Meanwhile seekers of budding alpha-makers circle the globe, investigating managers from Alabama to New Zealand.
HedgeFundSmarts 
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