Wednesday, May 22, 2013
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Macro Risk Advisors' Dean Curnutt |
By Dean Curnutt
Last year, while presenting to MBA candidates at the University of Chicago's Booth School of Business, I asked students what industry and specialty they intended to pursue after graduation. Consulting, investment management and marketing were areas of interest. Private equity was hot and investment banking remained a sought after destination. But not a single student, by a show of hands, indicated an interest in sales and trading. I suspected there would be less interest than there was a few years ago, but this was truly surprising. So what exactly is going on here?
The answer begins with cutbacks made to Wall Street training programs. For the better part of the last 20 years, bulge bracket sell-side firms have run large, organized and successful programs aimed at finding and then harvesting young talent. Wall Street dealers have traditionally been a consistent presence in campus recruiting programs at top undergraduate and graduate institutions. At the MBA level, firms often hired individuals with no previous exposure to financial markets or products. Underpinning these "athlete" hires was a view that given the proper training, a talented individual could learn to excel in a Wall Street role.
The 2008 crisis has had lasting change on the industry. Revenue for the investment banking industry is down more than 30 percent since 2009, even though things are better than at the depths of the crisis. The financial industry's return on equity, historically in the 20-25 percent range, is roughly half of that, according to Boston Consulting Group. When profits are down, cost containment becomes important, leaving expensive initiatives like training programs vulnerable. Recruiting team staffing, visits to campus, team events, and the opportunity cost of time to teach classes all add up from a cost perspective. The funding has not been available to run them at close to the scale they had been and even the largest firms are scaling back on the resources they devote to training programs.
The pressures on Wall Street profitability are secular in nature and show little sign of abating. Trading volumes are low and increasingly going electronic. Proprietary risk taking by dealers is being regulated away, and historically bumper products like credit derivatives are being pushed to more transparent and less profitable exchange traded venues. Despite less favorable business dynamics, investment in the process of training young professionals is still extremely, and possibly systemically, important for Wall Street. As the pace of industry change and the level of competition are only set to intensify, investment in young talent will prove to be money well spent over the long run.
While the past five years have been quite challenging for the sell-side, they provide an extremely rich narrative through which to educate young professionals. The chaos that ensued in 2008 led to extreme pricing dislocations and a wholesale breakdown of many hedging techniques. Traders who managed risk through this period are in a great position to pass along lessons of the crisis to younger colleagues. What hedges should have worked but did not? What outside-the-box thinking proved effective? Wall Street professionals, having endured a dramatic environment for market risk over the past several years, can equip their younger colleagues with tools that better prepare them and clients for the next crisis.
Even though finance is complex and fast moving, its fundamentals are very teachable. The real world market pricing of options, for example, is closely tied to the textbook theory of derivatives valuation. Relative prices observed in the option markets are largely governed by the same arbitrage relationships that are taught in business school classrooms. In fixed income, a host of cash flow based securities - swaps, bonds, FRAs, and futures - all carry a similar risk profile, but subtle differences must be accounted for to ensure the relative prices are fair. This bond math and other fundamentals can and should be taught to the young professionals that join Wall Street dealers.
Other aspects of the sell-side client service model also need to be taught, though the education process here is more highly nuanced. For example, on a fast-paced execution desk, there are countless (and potentially costly) mistakes ready to be made by the junior sales associate who has not received proper guidance. "Trial by fire" may be the model that trading desks fall back on, but it is both lazy and potentially perilous. This is especially the case since nearly every aspect of the client-salesperson-trader interaction can be anticipated and, as a result, taught.
This much-needed training can be accomplished by simply taking the time to map out various scenarios and creating mock trading interactions around them. These exercises can pass along the perspective and judgment that are critical in fast moving, high-risk situations. With these practice sessions, the junior salesperson is left in a considerably better position to respond to a live situation having seen and experienced the playbook.
While it may be self-evident, all of this matters because Wall Street has always been a client-driven business focused on delivering solutions. The challenges that clients, especially hedge funds, face are indeed formidable. They must deliver favorable risk adjusted returns in a low rate environment fueled by an unprecedented degree of central bank policy accommodation. They are also asked to anticipate and insulate portfolios from the next potential financial market shock.
As markets will surely bring many surprises in the years to come, clients will need the expertise and problem solving that Wall Street can offer more than ever. The turmoil of 2008 continues to create industry wide headwinds, but as the saying goes, "never let a good crisis go to waste." Investment in the growth of young professionals is critical to enabling the sell-side to meet the needs of its client base, especially as the world of risk becomes more complex. Wall Street firms that take the long view and commit to training and harvesting young talent will be the ones that come out ahead.
Dean Curnutt is CEO of Macro Risk Advisors LLC, an equity derivatives strategy and execution firm that specializes in translating proprietary market intelligence into actionable trade ideas for institutional clients. The New York-based firm is a registered broker/dealer with the FINRA.
Thursday, April 25, 2013
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Finect president Jennifer Openshaw |
By Jennifer Openshaw
A year since President Barack Obama signed the 2012 Jumpstart Our Business Startups (JOBS) Act, hedge funds, asset managers and other sponsors of private placement offerings still eagerly await the completion of rules surrounding the marketing of those offerings to accredited investors.
The JOBS Act, designed to boost job development and help small companies raise capital, contains a provision loosening the Securities and Exchange Commission’s long-standing ban under Regulation D on general advertising for private placement offerings, making it easier for hedge funds and others to tap new investors. But consumer advocates say there aren’t enough protections for investors who may lack the sophistication for playing in this alternative market. (Some already are hinting they may take the SEC to court if they think the protections are insufficient.)
It’s a divisive issue, but the truth is that the financial services industry has a vested interest in making sure investors are sufficiently protected. The last thing industry leaders want is another Bernard Madoff who leads regulators to enact even stricter and perhaps more onerous rules while jeopardizing the integrity of our industry.
We all know the response to the consumer argument: Only accredited investors — individuals with a net worth exceeding $1 million — are supposed to be approached for this kind of higher-level investing. But there are some flaws in that thinking.
Plenty of consumers sold a house at the top of the market and now technically meet the definition of accredited investor. Their timing may have been fortuitous, but it doesn’t make them sophisticated.
Industry players need to think this through. Private placements have often laid waste to the portfolios of unwary investors. The wreckage hasn’t been confined to consumers, either.
Over a two-year period at least 21 independent broker-dealers that sold toxic private placements folded or planned to sell themselves, WealthManagement.com reported in 2011.
Even established firms with well-known names have gotten in trouble. Two years ago Ameriprise Financial sold its Securities America division over failures related to fraudulent private placements that its brokers marketed. And last fall the retail industry watchdog Financial Industry Regulatory Authority levied a $14 million fine against financial adviser David Lerner Associates, suspending Lerner himself for a year and accusing the firm of selling a complicated nontraded real estate investment trust to unsophisticated and elderly clients.
The financial industry historically has bemoaned the regulatory burdens under which it labors. But if bad actors sell products fraudulently or investors complain about unsuitable recommendations that blow up their retirement savings, you can be sure that more regulation will be in store.
Markets are replete with temptations that can trip up investors time and again. In the current environment, low yields have left individual investors hungry for alternatives to 2 percent on a long-term CD — or nothing if they’re among those still sitting on the sidelines of the stock market. They might jump at a new product, especially if it’s marketed by someone calling himself a financial adviser.
The financial industry can best protect its own interests by protecting the investors themselves. For starters, it helps to target the right investor. Defined wealth for accredited investors ought to be a larger number; one call for minimum income of $400,000 and net worth of $2.5 million is a good benchmark. Financial services firms should embrace this definition to ensure fair play.
Firms also need to take greater care in the verification process. JOBS requires that securities issuers take merely “reasonable steps” to verify that buyers are sufficiently wealthy. A more vigorous process is warranted. With new technology platforms coming to market, hedge funds and other asset managers can now take advantage of social media for information distribution but can still target accredited investors.
Finally, it’s better to standardize disclosures. These are complicated products but there’s no reason we can’t bring uniformity, at a minimum, to facilitate decision-making. The Consumer Financial Protection Bureau simplified mortgage statements and has created model disclosure forms for the credit card and college financing industries to explain critical loan elements — interest rates, fees and total costs — in a meaningful way to borrowers. Investors, too, are entitled to similar treatment with alternative investments so they can evaluate possible gains and losses in volatile markets with their eyes wide open.
Financial managers can protect their own future by focusing on what’s best for the investors buying their products. The industry needs to lead now, before the next financial crisis erodes investor trust still further.
Jennifer Openshaw is the president of Finect, the online network for the financial services industry. She previously served in the California state treasurer’s office and was founder and CEO of Women’s Financial Network, now part of Siebert Financial Corp. She is the author of “The Millionaire Zone” (Hyperion) .
Thursday, April 18, 2013
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| SEC Chairman Mary Jo White; Photo: (Bloomberg) |
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By Richard Baker
Former U.S. attorney Mary Jo White assumes the chairmanship of the Securities and Exchange Commission with the table set for a number of reforms that could benefit investors and markets. While she will have no shortage of issues to address, there are several priorities that she should focus on early in her administration.
With Chairman White’s experience as a prosecutor, she will continue the SEC’s focus on enforcement in the marketplace and we support her in this mission. Rooting out bad actors, wherever they may be, is essential to the fair, efficient and transparent function of our capital markets. The SEC must continue to take a hardline approach, enforcing the rules of the road for the benefit of all investors.
As for the rules awaiting implementation, which Chairman White noted in her Senate testimony, the SEC needs to adopt the Jumpstart Our Business Startups, or JOBS, Act rules for Regulation D offerings. Last April, with broad bipartisan support, Congress enacted the JOBS Act to modernize several aspects of the securities laws and ignite job growth. President Barack Obama supported the bill and signed it into law. Among the provisions in the bill, Congress instructed the SEC to amend its rules to help companies raise funds in “private placements” under SEC Regulation D, that is, certain securities offerings not involving sales to the public. Old Regulation D prohibits virtually any type of public communication, effectively silencing all private offerings, including offerings for private funds. The SEC proposed rules to implement these JOBS Act provisions last August but has not adopted them.
The value of these changes is not only in greater transparency for investors, but in helping to realize one of the main goals of the JOBS Act: helping businesses raise capital. There is real consensus that our economic recovery could stall if capital does not get off the sidelines. By adopting the rule the SEC proposed last August, Chairman White can help increase business investment, an important national priority.
As the JOBS Act would apply to hedge funds and other private companies, the SEC has been pressured to narrowly implement this law with respect to the way these companies are allowed to communicate with qualified investors, for fear it will endanger retail investors. It will not. The JOBS Act changes only who may know about a company conducting a Regulation D offering; it does not change who may buy into a Regulation D offering. The JOBS Act limits investments in such companies to qualified investors, including individuals with at least $1 million of net worth, excluding their primary residence. Congress has also constructively asked the SEC to review this qualification level in 2014 and increase it if appropriate.
Another issue significant to investors and market efficiency is the coordination of regulation between the SEC and the U.S. Commodity Futures Trading Commission. The Dodd-Frank Act and other regulatory mandates have required many hedge fund managers to register with both the SEC and the CFTC. In addition to having separate and different registration procedures, each agency requires its own systemic risk reporting.
While the SEC and CFTC made efforts to coordinate some rules, others have been implemented in a piecemeal fashion, resulting in burdensome and sometimes conflicting regulations that have been damaging to investors and the capital markets. The U.S. is perhaps the only industrialized country that separates securities and futures regulation, and as a matter of international competitiveness, the SEC and CFTC must coordinate more effectively. We urge Chairman White to work with CFTC chairman Gary Gensler to develop a better-coordinated regulatory framework.
Finally, the SEC should also work to finalize the Dodd-Frank rules for security-based swaps. These derivatives are essential financial tools to manage risks for investors. Dodd-Frank imposes an extensive regulatory framework on derivatives to prevent a repetition of events such as the collapse of AIG. Although the SEC has issued proposals related to many of the security-based swap rules, the SEC has yet to finalize many of those rules.
Among Dodd-Frank’s most important requirements is a law that requires the most active market participants to clear swaps through a central clearinghouse, as is commonly done with stock trades. Clearinghouses process trades, eliminating credit risk between the parties to the original trade and reducing the likelihood of systemic problems. These rules can provide extensive protections and reduce unneeded cost.
We urge Chairman White to swiftly complete all of the SEC’s clearing rules for security-based swaps. The CFTC largely has completed its work; the SEC must do its part.
Rulemaking is challenging and complex. The SEC has done an admirable work in soliciting views from a range of stakeholders before finalizing rules, but Chairman White’s SEC must now focus on finishing the job. There is no need for further delay. As she said in her confirmation hearing, “The SEC needs to get the rules right, but it also needs to get them done.”
As investors, we could not agree more.
Richard Baker is president and CEO of the Managed Funds Association of Washington, D.C., the largest hedge fund industry trade group in the U.S.
Thursday, April 04, 2013
By Jason Wallace
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Contingent Macro Advisors partner Jason Wallace |
Leadership takes on several styles but there seems to be a growing need for one particular approach — strategic leadership — in hedge funds.
In other industries, such as healthcare, information technology, consumer staples and retail, this approach has emerged as a specific executive role. However, there have been few executive-level strategy positions within the hedge fund industry until recently. Most hedge fund principals exhibit leadership styles but not specifically strategic leadership, and many resist the idea.
“Why should I add headcount through the addition of a chief strategy officer? Isn’t that what I do — lead strategically?” asks one hedge fund CEO in a recent study.
The reason for this is rooted in how hedge funds initially developed and grew. The industry is only now emerging from the first two phases of a hedge fund’s lifecycle: the early stage and innovation stage and the cost-shakeout stage or maturity stage, depending on the lifecycle model used. Thus hedge funds are being pressed to evolve from the small partnerships they once were to strategy-minded institutions characteristic of mature industries.
Strategic leadership is a focus on what the firm envisions itself to be and what steps need to take place in order to achieve that vision. Thus it requires visionary elements and execution skills on the part of management to accomplish the vision. Strategic leaders then develop, acquire buy-in and implement this vision, encompassing the firm’s mission and what values the firm wishes to inculcate and cultivate across business lines.
There are several reasons why a still-growing hedge fund firm would add strategy officers to the top level management team. For one thing, CEOs are generally stretched with multiple responsibilities for them to focus effectively on ensuring execution of the firm’s vision and business strategy across the institution.
For another, part of implementation is acquiring buy-in and ownership from other C-level management and line-managers alike. The strategic leader can ask tough questions that CEOs and direct managers cannot ask or that they may not want to hear honest answers to.
Bob Savage, CEO of Track.com and chief strategist at FX Concepts, says that the CSO “really acts as an ombudsman of sorts” who acts in such a way he or she “facilitates” other leaders’ ability to come up with ideas that can be credited to them.
“There really is no room for ego,” Savage adds. Indeed humility is one of the most important — and perhaps the most difficult — traits that a strategy executive could have.
Ultimately, most hedge fund leaders are not strategic leaders. They can, in fact, be great leaders who exhibit other styles of leadership. But most hedge funds were started by a portfolio manager, rather than a business manager or someone skilled in running a company and managing relationships. Even if the firm launched with the now essential COO role intact, these COOs generally have experience and skills in running operations, not designing and executing firm-wide, innovative, and dynamic growth strategies.
A casual survey of hedge fund leaders show a generally positive reception to the development of a CSO role within organizations, while they acknowledge some challenges. Two arguments against it: One is based on the long-standing premise that investment management has only two pillars, investment returns and asset growth, and that anything that compromises these two should be dismissed; the other is that it is the risk-reward profile to creating a new strategic leadership position is simply not compelling.
Both objections are valid. Clearly investment returns and fundraising will continue to be the most important elements to success. However, as the industry enters a new growth phase, a strategy pillar could develop that can support the other two. As for the second argument, the objection is usually made where the current leadership either doesn’t want to, or doesn’t know how to, transfer strategic decision rights to another individual, or sees no proven value in it. How many times have you experienced this?
One CEO of a prominent hedge fund firm, who declined to be named, once articulated this challenge succinctly: “To me, the tough part is the concept of buy-in.” The CEO needs to be able to ‘let go’ and allow someone else to help drive the future of the business, even though any strategy decision needs the CEO’s sign off in advance. Top managers must be good, effective partners for the CSO to succeed. Otherwise execution may be undermined.
This risk-reward assessment is even more important in smaller hedge funds where resources are scarce. Hedge funds need the resources and revenue minimums to be able to add a strategic leader to a team. It remains to be seen what the capital requirements need to be. At the very least, strategic leadership needs to be undertaken by one of the principals of the firm. If the hedge fund CEO does not possess a strategic leadership style, there needs to be someone else alongside the CEO who does.
Despite the valid arguments against having CSO positions, the need for strategic leadership will continue to compel hedge fund leaders to redesign their firms to achieve high performance as they evolve into the next growth phase.
Jason Wallace is a partner at Contingent Macro Advisors, a global macro research, advisory and asset management firm based in Lafayette, California.
Thursday, March 21, 2013
By Francois Buclez
In case you haven’t noticed, there’s been a lot of discussion and hand-wringing over the fund-of-funds segment of the hedge fund industry. Is it dead? Is it dying? There are those who think so. More subtly, is there any merit to the concerns expressed about muted performance or lack of value for money?
Investors who might want or need a fund-of-funds product are in a bit of a quandary. Should they move forward with fund of hedge fund allocations? Even if they can’t themselves invest directly, due to lack of internal resources, for example, we are seeing investors struggle to justify allocations to funds of hedge funds. Several institutional investors have told us they are asking their consultants to answer the question “Why are we invested with these managers?” None of this paints a pretty picture, suggesting a homogenized, outdated and static product offering that has failed to deliver value to its investors.
Many funds of hedge funds are lowering fees. But lowering fees on its own is not a panacea. The issue at heart is whether the services offered by fund of funds are worth the fees paid by investors. Are they performing an asset allocation exercise and outsourcing the ongoing risk exposures to the selected underlying managers? Or are they exercising their investment acumen to take and manage risks according to their own views? It is useful to compare them to either managers or consultants and what service elements of each of these they are delivering.
The Concierge
The consultancy or advisory model is the best-known path, which seems to be increasingly adopted by the larger and more classic fund of hedge funds. This involves creating bespoke portfolios of hedge funds with lower fees and lesser discretion. Many of these mandates are now being explicitly described as emphasizing knowledge sharing. Thus we are seeing many clients aim to develop these important skill sets internally, suggesting that asset allocation and due diligence efforts are becoming commoditized.
The Building Block
Funds of hedge funds offering specialized exposures to a region or a strategy also appear to be a valid path. These can be useful in filling gaps by those who have gone direct with large core managers or even those who have adopted hedge fund exposures into their traditional allocation buckets. For example, some investors have allocated to long-short fund-of-funds managers within their equity allocation instead of as a distinct absolute return exposure. Others may seek specified hedge fund exposures given policy requirements that limit their scope.
The Dedicated Specialist
A further progression along the curve of added value could be funds of hedge funds that focus on emerging managers or seeding other managers. Working with emerging and smaller funds is a step beyond allocating to the readily identified managers who’ve built investor relations infrastructure with institutional investors in mind. Seeding managers goes even further as there are often fewer of the traditional criteria in place on which selection decisions are usually based. Elements of private equity skills should be expected of those building seeding funds.
The Hybrid
Certain funds of hedge funds practice a hybrid approach such as including direct trades or running an overlay in conjunction with investing in underlying managers. The overlay and direct investment activity is a reflection of their insight into the marketplace and serves to mitigate the limitations of the traditional fund-of-hedge-fund structure. They also facilitate a more efficient portfolio construction. For example, if an attractive opportunity has been identified but the portfolio is fully invested, it could take months to process the redemptions in order to make a meaningful allocation.
The overlay feature is often limited in scope and used primarily as a hedging function. However, as managers have the capability, they may use the overlay as a dynamic beta management tool for reshaping portfolio positioning. In this context, the overlay offers the flexibility to reduce or enhance select exposures, or to modify overall risk levels in a rapidly changing market environment
Less common in a fund-of-hedge-fund format is the combination of security selection with manager selection. The primary difference between running an overlay and direct security selection is the linkage with the overall portfolio and the nature of the instruments traded. While both are for enhancement of risk and return, the overlay can be considered more of a modification of existing portfolio exposures and direct securities would be considered additive. Direct exposures can be a pragmatic solution to enhancing returns by taking advantage of inefficiencies that are ad hoc, or not easily categorized, and thus orphaned by a large group of investors.
A hybrid model has other benefits. Lower overall fees can be a relevant differentiator between funds-of-hedge-fund managers. Given that there is only one manager involved in the direct exposures of a hybrid fund, these exposures would be subject to a single layer of fees, thus reducing fees by the amount of overall internally managed exposures.
Investors should bear in mind that fund of hedge funds that actively allocate to both managers and direct market exposures require an additional layer of research and skills above those associated with manager selection alone.
So where does all this leave the fund-of-funds model? Underneath the generic category, a range of product offerings has evolved. The need for funds of hedge funds may vary by client, but the need is not going away. If you can match the service offering to your needs, there is vibrancy and value for money to be found.
Francois Buclez is CEO and CIO of Cube Capital, a $1.2 billion global alternative investment firm with offices in London and Hong Kong.