The Future of Hedge Funds...........Will They Survive?

The Future of Hedge Funds..........Will they survive?

Several years ago I managed money for a small group of Family Office clients.  I was responsible for the entire investment program from asset allocation to portfolio management.  I found myself looking for enhancements to my existing portfolios.  So the search began for diversification benefit and potentially some “Hedge Fund” exposure.  First off, what is a Hedge Fund? 

Hedge Fund Basics

Hedge Funds can be defined in many ways.  There are probably 25 to 30 main styles of funds and it would take far too long to describe each one.  There are countless other “black box” funds in existence that do not fit any conventional classification.  The term Hedge fund has since become synonymous with the “alternative investment” asset class in a client’s asset allocation. 

Hedge Funds are primarily sold to investors as a way to reduce volatility in a portfolio.  The funds often times display a low correlation coefficient which means that they do not move in the same direction as your main asset classes.  In fact, some funds have a negative correlation objective which means that the funds are designed to move in the opposite direction as the main asset classes in a portfolio.

Hedge Funds normally do not have daily liquidity and have somewhat expensive fee structures.  You often times hear Hedge Fund fee structures described as 2 and 20.  This means the fee includes 2% management fee and 20% of the fund profits.  This is pretty hefty when you consider most fee based advisors are in the 1% of assets under management ballpark. 

There would be a lively debate among advisors as to the value of Hedge Funds.  In my case, I never did add Hedge Fund exposure to our portfolios.  The value debate would be especially heated these days where the performance of this broad group has been seen as far below expectations. 

The group has been criticized for high fees and high correlation to the broad market.  I am always puzzled when I hear a Hedge Fund manager speak of good returns in a Bull Market.  If the fund is supposed to be negatively correlated to the broad market then shouldn’t the fund be down when the S&P is having a good year? 

Will Investors begin to move away from Hedge Funds?

I think we are on the edge of an evolution in Portfolio Design.  With the expansion of investment vehicle options, there are now more ways to build portfolios than ever before.  The advent of new portfolio building blocks has given investment managers new ways to not only grow capital, but also provide better downside protection. 

After Q4 2008 – Q1 2009, investors have been nervous about potential systemic market moves.  This has contributed to the strong interest in Hedge Funds and other alternative investments to theoretically protect portfolios in turbulent times.  The search for better downside protection has given way to a new direction in portfolio research. 

Some of this new research reveals the existence of opportunities to give investors better downside protection without Hedge Funds and the negative features they bring to a portfolio.  Better downside protection, lower fees, and liquidity spell trouble for the Hedge Fund industry.

Investment Advisors are continuing to leverage science and math.  We are still looking for better ways to grow and protect capital.  Will our quest to improve upon the 2013 accepted norms of portfolio design lead us to the “flying car” of wealth management?  I think we are well on our way.           

 

         

   

 

Buy, Sell, or Hold

Buy, Sell, or Hold


What should you do when you start to feel that the markets are under pressure? You start to notice that some of the holdings in your portfolio are no longer in the green. Some are flat while others are in the red. Should you stay the course or should you sell?

First of all, if you are losing sleep regarding your portfolio, you should call your advisor. If you are a self directed investor, perhaps hiring an advisor to review your portfolio on a one time basis is an option for you. Some advisors offer this service. Either way your goal should be to reaffirm or reinforce your investment strategy and portfolio design.

In my own practice, portfolios are optimized while looking back through various market cycles. This gives insight into how the portfolio should perform over an extended period of time. Buy, sell, or hold decisions should be made to advance the long term objective you set for your initial portfolio. Be careful not to make decisions based on some frenzied television personality.

Financial news content can be a little confusing to investors. Most of the time there are two opposing views that appear to be in stark contrast when in fact the major difference is simply time horizon. While an active trader might not see the market as favorable the investor might see the market as ideal.

Investment decisions and trading decisions are not the same thing

Much of the investment discussion these days revolves around trading ideas and short term opportunities. This is in stark contrast to the more investment driven thought of the past. Tweets are moving markets. Are you missing out in your portfolio? I don’t believe so. Most of the time, too much activity in a portfolio leads to speculation and miss-timed moves. Investing is not unlike driving on an icy road. Hold the wheel as still as possible, don’t make any jerky moves, look ahead, and pay attention.

Never forget to keep your investment objective fresh in your mind and don’t be afraid to revisit your decision making process. Most importantly, be careful not to be influenced by the media.

Ryan

Tesla and a Bundt Cake, the new market indicators

Before you read this please let me tell you that I love the new Tesla. It is a fantastic automotive achievement. I am a big Bundt Cake fan as well. This entry is supposed to be fun.

Our capital market system is very complex. Conclusions regarding its readiness for deploying investment capital can be drawn in a multitude of ways. What do the indicators show? Is the market overbought? Is it oversold? Is the economy too frothy? Are we in a bubble of some kind? Invest or raise cash? Decisions decisions.

Let’s put aside the conventional indicators and look at some perhaps non-conventional indicators. So how is the economy doing anyway? Let’s take a look. While we don’t appear to be in any sort of bubble right now, some consumer behavior might lead us to believe otherwise.

I have noticed the overwhelming popularity of the new Tesla Sedan in my community. I would say this is a very positive sign for our economy. Normally when consumers spend $90,000 on a car, they require a range of greater than 300 miles. In this economy, we are content throwing  all elements of practicality to the wind in favor of the new techie ride. 

By the way, the new Dodge Dart has a range of 600 miles. Yep, for roughly 19k, you can double the range of the Tesla and when it gets low on gas, you can fill it up and drive another 600 miles. You don’t even have to wait for the recharge.

Speaking of recharging your new Tesla, I know where you might find one of those super convenient charging stations. I recently spied a new bakery that was selling the beloved Bundt Cake for Tesla like prices. $40 will get you a 10 inch Bundt Cake, just like Mom used to make. $65 will get you a two tier cake. Wow. That’s cheap. Only time will tell before we see the parking spaces right in front of the gourmet Bundt Cake shop equipped with Tesla charging stations.

So while you are looking at your Tesla app on your new Iphone or Andriod phone, you can call the bakery ahead of time to order a trunk load of high end gourmet Bundt Cakes. I don’t think I will be driving a Tesla soon. I have a new Windows Phone and it doesn’t have the Tesla app. Bummer.  I do sort of feel like making a Bundt Cake.  As the tag line goes, "let the Bundt Cake do the talking". 

Next time back to investment discussions.  Look for Buy, Sell, or Hold coming soon

Do you have Unclaimed Property

Here is a WealthThought focused on the personal finance side.

Somebody may be trying to return property to you or refund money that they owe you!

A few months ago I received a letter informing me that I had several unclaimed property accounts for a pretty nice little sum. In other words, several parties had attempted to return money to me and were unsuccessful. I have never received a letter of this kind and I was very interested to find out more.

I called the company who sent the letter and they confirmed that people were trying to return money to me and that they would retrieve it for a fee. The fee was small, but now I was starting to get skeptical. I ended the phone call and set out to research more facts about unclaimed property. There are many reasons why someone may have unclaimed property. In my case, I had moved several years ago and the parties simply could not reach me. After a period of time, unsuccessful attempts to refund money to its rightful owner require the organization to send it to the State until it is claimed. You do not need a third party to help you find unclaimed property that you may have. You can do a search right from the following site here in California without using a middle man.

When you do your search, make sure you are mindful of the different ways people can identify you. For example, if you are married, do a search with both your married and maiden names. Once you find unclaimed property owed to you, by using this source you can retrieve your property without paying a fee. You simply fill out their forms, send them to the state, and check back on the site to keep track of the status of your claim. This is fun and you never know. You may get lucky. An old health insurance provider may be trying to refund a premium you overpaid or a relative may have left you part of their estate. Happy searching!

Here is the California link http://scoweb.sco.ca.gov/UCP/Default.aspx

WealthThought2

Understanding a key limitation to Modern Portfolio Theory.

When Harry Markowitz introduced his Modern Portfolio Theory in 1952, it revolutionized portfolio design forever. MPT explores the concept of maximizing portfolio return for a given level of risk. The theory is as relevant today as it was in 1952. A deep understanding of its elements requires a strong competency of various statistical mathematical principles. One of the key metrics often used when Portfolio Managers discuss the efficiency of their design reveals a limitation of the theory itself.

Standard Deviation is used to measure the expected volatility of a given portfolio. MPT assumes that rational investors should prefer the portfolio with the lowest standard deviation and the solution with the tightest range of variance versus the one with the widest swings in performance. Here is where it gets a bit tricky. MPT also assumes that investors have quadratic utility which means that they have an equal preference for the upside range of the standard deviation as they do to the downside range of the standard deviation. Equal preference for negative returns and positive returns is not rational. Investors will tell you that they have a much greater preference for the upside range then they do for the downside range. I will discuss this bi-linear utility in future WealthThoughts.

In spite of this limitation, MPT remains the core framework for portfolio design in the modern era. We will continue to study how mathematicians improve the application of this time tested theory.

WealthThought1

Don't get thrown off course

Markets fluctuate and so do your emotions, especially when market action favors the downside. The recent market weakness has caused some investors to get a bit nervous. We are barraged with market debate on a daily basis. The long term biased view is at times directly counter to the shorter or trading biased view. To make matters worse, unemployment is still high and recent data indicates that more people are taking loans from their 401k plans. So how does the news of the day affect your portfolio? Portfolios are designed with the long term objective in mind. Asset allocation models are constructed based on many years of historical data. Market weakness can be a great time to rebalance your portfolio and add to the exposure that is necessary to maintain your appropriate asset allocation. If your destination is far beyond the horizon, don’t let the obstacles that are close at hand throw you off course.

Tortoise or the Hare

In our world of constant media exposure, individual investors can be confused by many mixed messages. Live real time financial market news stations offer a steady stream of analytical programming. One popular programming format involves people with opposing views debating topics in an exchange format that often time digresses into a shouting match.

While political content shows can be easier to understand, investment programs can be a bit more confusing. This is because much of the debate regarding our capital markets often times involves people with one specific critically different fundamental basis for their views: Time horizon.

Investment advisors tend to take a longer term outlook while traders prefer to look at much shorter time periods. For example, an investment advisor might believe that the market is a good place for investors to gain equity exposure because of the long term prospects (market cycles can be measured anywhere between 5 and 10 years), while an active trader might refer to the market as having less potential because of economic and or political events that will take shape over the next week. Rationale behind long term Investment strategy and portfolio design can often times run counter to the instincts of shorter term market tacticians. While both sides of the debate hold valid views, the discourse may seem at odds.

Having a formal investment strategy drafted (Investment Policy Statement or IPS) can help clients feel a sense of confidence in their longer term objective while also addressing some of the more tactical issues regarding their portfolios. Achieving investment objectives requires broad perspective. Short term cycles require as much attention as longer term cycles. The most important factor is staying focused on the race. Whether you are the tortoise or the hare, each perspective should drive and anticipate clear action steps throughout varying stages of the capital management process.