Posts in Hedge Funds
Warren Buffet Makes A Bet

Warren Buffet, who many consider to be one of history's greatest investors, has made a million dollar wager.  He made a bet that the S&P 500 Index will outperform a group of five hedge fund-of-funds after fees at the end of the next 10 years.  The bet was with one of the principals at Protege, a hedge fund-of-funds shop.  The winnings will go to the champion's favorite charity.

John Mauldin, who writes a very informative weekly newsletter, researched this wager after it was first reported in Fortune magazine.  He lays out several arguments for why he believes that Buffet may be left holding the short end of the stick this time.  Please click on this link to view the details of this very interesting and intriguing wager.

130/30 Strategies Becoming Mainstream

HedgeWorld recently published an article on their subscription website (sign up for free at www.hedgeworld.com) detailing the results of a survey conducted by business media firm Terrapinn Ltd., regarding the increased use of 130/30 strategies. The conclusion of the study was that 130/30 strategies are no longer just a fad but are slowly becoming an integral part of an investment portfolio. The biggest concern among those polled as to why they have not implemented the strategy into their portfolio is due to manager selection; many feel they don’t have confidence in the manager’s shorting ability. Another interesting fact in the survey was that a majority of managers who offer 130/30 strategies do so because they feel it creates a competitive advantage.

At Innovest, we are currently conducting research on the viability of 130/30 strategies. We believe they very well may have merit and a place in a portfolio.  However, with most track records less than three years long, it is difficult to make a complete analysis. As these strategies gain traction and there are more data points to analyze (especially the volatile months of July and August 2007), we will form more of an opinion as to if and when we may advocate implementing them into client portfolios. As with any investment we analyze, it is important to not only look just at performance but at the team managing the strategy. Since many “long-only” shops don’t have a great deal of experience shorting, it is extremely important to understand the shorting process and the inherent risks it brings.

Please check back often to see our continuing thoughts on 130/30 strategies.

Hedge Fund Investing

The last few months the investing community has experienced some fairly dramatic hedge fund "blow-ups". These debacles are nothing new, as they tend to happen from time to time.  It can be very difficult for hedge fund investors to avoid all of them, as evidenced by the demise of funds such as Sowood, a Harvard-bred fund that was able to raise substantial capital from major institutions including Harvard's own endowment. Sowood's stellar background and enviable client list did not help it avoid losing more than half of its capital in a matter of days. Similar stories have surrounded funds at Bear Stearns, Basis Capital and more recently a plethora of large, well respected quantitative funds.

At Innovest, the recent turmoil in the hedge fund arena has further validated our approach to hedge fund investing: choosing to invest directly in hedge fund of funds rather than single or multi-strategy hedge funds. While we have not been immune to losses stemming from many of the recent crises, our client's losses have been substantially muted in comparison to investors who had direct positions in affected hedge funds. For more on our approach see this white paper that Innovest recently produced regarding the subject of hedge fund investing.

A Demon of Our Own Design

I am currently reading A Demon of Our Own Design, an eerily prescient look at markets, hedge funds and risk. The author, Rick Bookstaber, also has a very insightful blog. Given the recent turmoil in the markets, particularly within quantitative based funds, this post is worth a read. It puts in perspective the dire headlines we have been reading, as well gives a decent explanation to many of the problems that caused recent market disruptions.

July Meetings

Listed below are the investment firms that Innovest met with during the month of July, either in our office or onsite. If you have questions regarding our thoughts on any of these firms, please feel free to contact us.

  • Benchmark Plus
  • Boston Company
  • Cadogan Management LLC
  • Centennial Partners
  • Eaton Vance
  • Fuller & Thaler
  • FutureSelect
  • Genesee Investments
  • Ironwood Capital Management
  • Legg Mason
  • Navallier & Associates, Inc.
  • Parametric Portfolio Associates
  • Portfolio Advisors
  • Quellos
  • Rainier Funds
  • Red Rocks Capital Partners
  • Royce & Associates LLC
  • Santa Barbara Asset Mgmt.
  • Wakefield Asset Management
  • Western Asset Management
Private Equity Investment Isn’t Just for the Wealthy Investor Anymore

It used to be that Private Equity investment was for the wealthy.  Not anymore. Red Rocks Capital in Golden, Colorado has created an index named the Listed Private Equity Index (LPE), consisting of public companies that invest in private equity deals. From this index a new ETF (available through PowerShares - Ticker: PSP) was created, allowing any investor to gain access to the asset class. Although investment in the ETF is not exactly a direct investment in the actual private equity deals, it is an investment in the companies that invest in private equity. In other words, the revenues of these public companies in the ETF are derived from the private equity deals in which they participate.
 
The ETF consists of at least 30 publicly traded companies that do business in the private equity arena. Together, these companies have investments in more than 1,000 private business deals diversified across all market caps, styles and various stages of business development.

The ETF is unlike a direct investment in a private equity fund, or fund of funds, which have:

1) Large minimum capital investment, usually $500,000 or more

2) Substantial lock-up periods where the investor may not be able to withdrawal their capital without a severe penalty

3) Relatively high fees that consists of a management fee (usually 1% or more) AND an incentive fee or share of profits generated (usually 5% or more) and

4) Lack of transparency.

The ETF on the other hand has no minimum investment, no lock-up, a 75 basis point expense ratio, and complete transparency of the companies it is invested in (but does not include the underlying private deals).

Although the terms are very favorable for the ETF, the investor needs to understand that they would not have an actual stake in any of the private deals, rather only an investment in the public companies that derive their revenue from those deals. Back-tested performance of the Listed Private Equity Index has proven to be not only appealing, but also has demonstrated a relatively low 0.72 correlation to the S&P 500 over the past 10 years. Additionally, even though there is no lock up period, investors allocating to the asset class should plan for a long time-horizon as most private equity deals take several years to work themselves out and revenues may not be booked until certain hurdles are achieved.

All in all, this new ETF is a great way for the “average investor” to gain access to an asset class that used
to be out of reach. For more information on Red Rocks Capital and to learn about the Listed Private Equity Index, go to www.listedprivateequity.com, and to learn more about the ETF derived from the Listed Private Equity Index, go to www.powershares.com.

CDOs and Recent Hedge Fund Woes

There has been much in the news recently regarding the implosion of two Bear Stearns hedge funds that were invested in CDOs that held sub-prime mortgages; mortgages to high risk borrowers that recently have been going into default at a much higher than had been anticipated rate. Below are links regarding the Bear Stearns blow-up as well as a decent explanation of what CDOs are and how they work.

Center of a Storm: How CDOs Work (WSJ subscription required. Alternative link here)
Entertaining Comments from Greg Newton
Bad News Letter from Bear Stearns (from WSJ)

Hedge Fund Scum

I have seen the hedge fund industry painted with many broad brushes, but this one seems particularly interesting. Stephen Jarislowsky, a Canadian billionaire and CEO of investment adviser Jarislowsky Fraser, did not mince words in a recent interview with the Financial Post. He referred to hedge funds as "a bunch of scum who make deals fast and force companies into taking short-term decisions whether they are in the best interests of shareholders or not". While at times this may be true, to refer to hedge fund industry as a whole in such manner seems intellectually dishonest and emotionally driven (he's not happy about being forced off a board). The practice he is so upset about is so-called "activist" investing, which has become very popular with certain hedge funds over the last few years. However, many would argue the opposite point, that activist investing has led to more streamlined businesses with more focused boards and management thereby unlocking shareholder value.  The point is, that painting investment strategies with a broad brush may entail less effort (especially when hedge funds are the target) but true analysis requires more critical thinking, lest you let your tunnel vision keep you from profitable opportunities.