By Nick Evans
"The hedge fund industry is doing itself a great disservice
by putting risk before return."
TCI founder Chris Hohn's forthright message in a compelling
address to the EuroHedge Summit in Paris in late May could
hardly have been better timed. Nor could it have struck a more
resonant note among all those who are trying to make sense of -
and make money in - this long period of financial markets
upheaval, unconventional economic/monetary policies and high
The notion that had been gaining currency earlier this year
that risk-on/risk-off (RORO) had gone away, and that markets
were being driven more by fundamentals than by policy-makers,
took a bit of a jolt at the end of May - and a rather bigger
one in June.
First it was Japan - which had been a core focus for many of
the managers that had been singing from the 'fundamentals are
back' hymn-sheet - that hit the skids, with the Nikkei falling
by 7% overnight between the two days of the Paris Summit.
Then came the dramatic rise in government bond yields -
apparently vindicating those who believe that the record-low
yields that have been seen during the last few years of zero
rates and endless QE are unsustainable, and that fixed-income
as an asset class represents a return-free risk that is heading
for a bloodbath once the stimulus tap is turned off or even
Since then, sell-offs in emerging-market debt and equity
markets, in credit and in other asset classes have further
fuelled the feeling that the world is not such a rosy or
improving place as many people were allowing themselves to
believe earlier in the year - and that the old adage of 'sell
in May and go away' would again have been a good one to
remember and act on.
Looming in the background is the growing concern that China
may be the biggest bubble of all - with the potential for a
shadow banking-style credit crunch that could rival or even
exceed that sparked by the US sub-prime meltdown in 2007-2008.
And central in the minds of all managers and investors is the
worry of what happens - and how to be positioned - if and when
government stimulus starts to dry up and interest rates begin
In such a changeable and still potentially perilous climate,
it would not be surprising if many of the new institutional
investors that have entered the hedge fund landscape in recent
years are somewhat unclear as to what their objectives are in
terms of risk and return.
For some it is to achieve long-term compound returns, of the
type that Hohn and many other old-style hedge fund managers
have unquestionably delivered - albeit with a degree of
volatility that is not to everyone's taste. For others, it is
to manage and mitigate risk.
For others still, it is to dampen volatility, provide
diversification or offer counterweights to the rest of their
investment portfolios. And, for some, it is a rather confused
and even contradictory combination of all of the above.
It does not help that the institutional investor world is so
prone to following rather faddish, pseudo-scientific, concepts
- like 'portable alpha' a few years ago or (much favoured of
late) 'smart beta' - that tend to last only for a brief period
before joining their predecessors in the dustbin.
And the rather inconsistent nature of so many institutional
investors - in terms of what it is that they actually want or
expect from hedge funds - has in turn had an impact on
managers, many of whom are struggling to appeal to and cater
for a new clientele with which they feel much less
instinctively attuned or aligned than with their investors of
Despite very strong performances from several individual
managers and funds, aggregate hedge fund returns over the last
few post-crash years have unquestionably been disappointing -
and very much less convincing than those that have been
generated over the longer term.
This may be down to one or more of several factors: to
ultra-low interest rates; to the RORO environment; to the
challenges of having to cope with artificial markets that are
so in thrall to policy-makers; to an element of over-crowding,
or over-capacity; or to a degree of fear and risk-aversion on
the part of managers themselves.
But it may also be down to the fact that so many managers
are trying to provide a risk/return profile that they believe
is attractive to institutional investors - many of whom, along
with their advisers, seem to put short-term volatility and risk
management ahead of long-term returns - but which, if it simply
results in high fees for mediocre returns, could ultimately
undermine the rationale for investing in hedge funds
And one cannot help feeling that, for hedge funds to thrive
in the new institutional world, they need - as Hohn and many
other like-minded managers believe - to reconnect with some of
the characteristics and convictions that made them so
compelling in the pre-institutional days.