Just like relative performance, you can't eat a media persona

I’m not going to write one word of background on one of the most undeservedly commented-on businesspeople in the City of London.  Instead, this post is a long-awaited good-riddance.  Nicola Horlick has dumbfounded this commentator in her every appearance in the media.  Her self-promotional tactics actively undermine her desire to gain credibility, and the results ain’t pretty.  (Check out this lovely appearance in an Economist piece, at the 1’36” mark.)  In reality, she has done nothing but lose investors’ money in ever more gobsmackingly incompetent ways.  (A 10% allocation to Madoff late in the fraud makes a mockery of hedge fund due diligence processes.)  As a result, 2009 hasn’t been kind to her, professionally.  Her businesses are being plucked out of her grasp at new lows in asset management valuation history. (View this up to the 30″ mark.)  Today’s FT mentioned Aberdeen paying GBP5m to manage GBP130m in assets in Horlick’s listed Bramdean vehicle, along with another GBP250m in assets from the Hampshire county council.  Well done, Ms. Horlick, does a 1.3% price-to-AuM valuation sufficiently “dampen you down?”  Real funds of funds managers get 4-6x that.  Do the rest of us a favor: leave the real work to real professionals and DON’T COME BACK.

Pandit: What's wrong with our name?

The gall of some people (I’m talking to you, John Dorfman, Jim O’Brien and John Havens).

Henny Sender and Francesco Guerrera reported in today’s FT that Mssrs. Dorfman, O’Brien and Havens are “poised to relaunch its troubled hedge fund operations after nearly two years of poor performance, internal strife and investor unrest.”  The story notes that the trio are so despairing of the Citi name, they wanted to brand the hedge fund unit after their prior firm, Carlton Hill.

Inexplicably, their superiors decided to continue to brandish their Scarlet Letter by changing the unit’s name ever-so-slightly from “Citi Alternative Investments” to “Citi Capital Advisors.”  Not sure they’ll be able to make a dent in their $2.5 billion asset-raising goal (they’re only $2.4 billion away!  Maybe the federal government could help…) with that catchy title.

From the tone of the article, Sender and Guerrera can’t believe their ears.  I can’t either.

In the off chance that you are planning to formalize your current taxpayer/bailed-out-bank relationship with Citi by investing in its newly branded hedge fund unit, I humbly present the following document for your reading pleasure.  It is a complaint lodged with the State of New York against Citi Alternative Investments and John Havens by an investor in one of Citi’s credit hedge funds.  It makes for interesting reading, weaving a tale of incompetence, lies and self-serving behavior by ex-Morgan Stanley execs over the interests of their clients.  Enjoy, and just like the SEC, you won’t be able to say that you weren’t warned.

CSO complaint_PDF

– Non-salesy marketers. Gone are the days of long steak dinners and golf-course deals. The slick transactional style is out, as is name-dropping and headline catch-phrases. “The concept of having a Rolodex is farfetched, because the Rolodex becomes dated,” says Tidd. What’s “in” is a solution-oriented, relationship-building approach, she says.

– Player-coaches. Candidates who can not only sell but also lead a team are especially desirable. Hedge funds need heads of sales and marketing “who can direct like an air-traffic controller in the marketing team,” says Tidd.

So, next time your interviewer asks, “What does your network look like?” ask them whether their “network” has done anything for them lately.  Only thoughtful investors who are either fresh to hedge funds or who were in them for the right reasons are now on the front foot committing capital.  The catatonic former hedge fund investor and his contact details will do nothing for your bottom line.  It is, rather, your ability to innovate the message, continually widen your circle of influence and lead that will translate into Euros through the door.

There’s too much potential money to be made to waste time on blinkered HR departments and headhunters, not to mention bankrupt investment approaches that are holding businesses back.  Clients are everything.  Focus on the clients.

Hello? Is anybody home?

Well, it’s the last act for Phil Duff, a hedge fund technocrat.  It’s a banal coda for someone who for years seemed to be able to conjure pension fund commitments out of thin air.  This brief missive attempts to explain why Mr. Duff’s momentum abruptly stopped.  In service thereof, most of what you need to know is already in the Bloomberg story–one just needs to spell it out.

The problem with technocrats is that they don’t actually add any value, in terms of managing money.  You can do your best to ensure that your hedge fund firm has more checks and balances than the next guy (in order to placate exceedingly clueless boards of investors that equate the number of boxes ticked with headline-risk-free performance).  However, all the beauteous bureaucratic baubles (just like relative performance) can’t be eaten. In 2008-2009, pensions were hungry–no–ravenous for positive compounding capital, and no amount of soothing process could entice people whose capital had been lost.  For that, you had to go to a time-honored source–a money-maker.

Enter Chris Shumway, who took over Duff’s follacious lease, according to Bloomberg.  Shumway may not be the most popular among his Tiger Cub peers, but his returns tell a story of prudent macro portfolio overlays on a powerful stockpicking engine–the hallmark of Tiger progeny around the world.  Here is a graphical representation of his returns, which far outstrip the equity index with less volatility.  The result?  Greater capital compounding.  Exactly what Duff’s clients desperately want and need.

Duff’s business proposition was all about wrapping that certain something, call it “alpha,” into an institutionally palatable package.  Problem is, guys and gals who can perform like Shumway don’t much like giving upside away to folks like Duff.  Just ask Curtis Macnguyen at Ivory Capital, who staged a hell of a Mexican standoff with Duff’s prior firm, FrontPoint Partners, back in 2006.

Maybe it’s time Duff moved away from tsutsumi and started paying more attention to what it really takes to consistently compound capital.  ‘Cause people ain’t buying what he’s selling…no more.

These wacky European funds know how to stretch for credibility.  Here is an excerpt from the most recent June 2009 monthly update from K1, the German fund of hedge funds recently embroiled in an international criminal investigation:

Current situation on suspended redemption of participation rights

• The K1 fund of hedge funds is invested in 74 target funds.

• Of these 74 target funds, 22 target funds are currently not accepting any terminations because they themselves first have to service their lending banks.

• Roughly USD 1,200,000,000 has already been paid out of the target funds to the banks.

• Roughly USD 600,000,000 still has to be paid to the banks.

• Of this amount of roughly USD 600,000,000, currently USD 450,000,000 is tied in the aforementioned 22 target funds.

• Overall, business transactions with the target funds is steadily improving. With the open-ended target funds, partial payments are made regularly.

• As things now stand, we assume on a rough estimate that it will take K1 a maximum of another 9 months for the remaining USD 600,000,000 to be paid completely, and that it will therefore not be able to redeem any participation rights during this period.

• Regardless of this suspension in the redemption of participation rights, investors may continue to subscribe participation rights and participate in performance.

We are convinced that this suspension in the redemption of participation rights also has a positive side,
ultimately having preserved investors from the panic realisation of losses.  We have broadly diversified our investments in 74 target funds so that we can see our way well through difficult times and quickly recover from loss phases.  Old stock market wisdom says that investors who have the courage to invest after a loss phase have picked a good starting point.  Anyone who invested in K1 after the low in October 08 achieved a return of 14% during the period of November 08 to June 09. The recovery phase is not yet over today either and can continue over the c

Yep, it just cuts off right there.

What the hell is “business transactions is steadily improving”?  What the hell is “another 9 months”?  What the hell is this “investors may continue to subscribe participation rights and participate in performance.”  How is your auditor going to swallow the marks you’ve decided to give yourself (+11.89% YTD) if there is almost HALF A BILLION DOLLARS MISSING?  Oh, wait, the auditor is the lovely “Prof. Josef A Becker in cooperation with Kosma, Saeftel & Kuenkele (Germany).”  I’m sure the good professor is doing the best he can.

Do yourself a favor: blacklist anyone who ever invested in this turkey–and definitely don’t let them touch your mon(k)ey.

Last week, a day before the good ship Galleon sunk due to a $20 million insider-trading investigation, there was another, comparatively overlooked story on an investigation into $50 million in disputed payments. Aside from the fact that $50 million is more than $20 million, there is another reason why the latter investigation should trump the former in terms of media coverage: It’s your money.

CalPERS is the closest thing the US has to a sovereign wealth fund in the Norwegian mold. It is the largest pension pot in the country and it also has a record of progressive shareholder activism and corporate governance policies.

Which is why the news that former board member Alfred Villalobos was being investigated for $50 million in placement fees he received to introduce large private equity funds to CalPERS is all the more potentially 1) damaging for CalPERS as an institution, 2) frightening for millions of pensioners across the nation and 3) a sad further revelation that a “money talks” culture is eroding prudent investment practices at the highest levels of institutional money management.

In response, former SEC chairman Arthur Levitt is lobbying for a new commission to investigate so-called “pay-to-play” arrangements on a national level. Leo Kolivakis is all for it and notes,

Investigators should look beyond the board of directors and conduct a thorough investigation to see if the investment staff are on the take. It’s not hard to have collusion among senior staff members to get an investment pass through some investment committee. Considering the enormous sums these public pension funds dole out every year to private funds, there needs to be a lot more checks and balances.

This commentator agrees with the spirit of this sentiment, as well as its presupposition that pay-to-play is endemic to the system, however, such an investigation may prove too difficult to implement effectively. The following points attempt to steer the discussion in a different direction:

• Running a pension fund is god-awfully difficult, and the people tasked with doing so are typically woefully inadequate. The fine upstanding citizens from all walks of life that sit on investment committees may be perfectly competent in their chosen field, but they have no business running a pension fund. Often, one or two finance “experts” dominate the agenda by dint of their relative literacy in these matters and the rest fall in line. Given this decision-making model, ill-conceived policies become the rule rather than the exception.
• The majority of pensions attempt to outsource some of their workload to independent gatekeepers called investment consultants. Although the track-record of their potential conflicts of interest is well-documented, there are some who do their best to advise their clients on a straight nominal advisory fee basis (trust me, their business model is not able to capture significant economic rents).
• Placement agents such as Mr. Villalobos, who are in a position to use their political influence directly on pension fund investment committees, should be the exception, rather than the rule, if only because their activity constitutes such blatant bad practice. Having been retained by the private equity firms, he cannot claim independent expertise and due diligence. If CalPERS’ investigation reveals any malfeasance, it will be with their own people, policies or procedures.
• The fact that Mr. Villalobos earned outsized economic rents on “access,” demonstrates again the systematic failure of the marketplace to deliver complex financial goods and services, even for “sophisticated investors.” We’ve seen this movie before.
• Essentially, placement agents work on commission. Incidentally, the UK regulator is currently in the process of banning this practice for all financial advisors in the retail market. If it’s good enough for retail, isn’t it good enough for you and your pension?

So, it’s plastered all over the wires that Raj Rajaratnam, 52, has been arrested under suspicion of insider trading on multiple counts. After a quick perusal of the complaint, it is apparent to this commentator that Galleon systematically operated its business on the edge of legality, habitually seeking out people with “edge” who were willing to color outside the lines of securities laws.

While there are many important facets to the story that will come out over time, I’d like to briefly comment on one issue. Too often, the “superstars” of the industry trade on performance, not on why their performance is generated and/or why they believe it will persist in the future.

Galleon was one of the funds known for showing investors and potential investors marketing materials that were light on process and heavy on results. As Mr. Rajaratnam delegated asset-raising to others at his firm and did not actively engage clients, a whiff of “fast money” emanated from the firm–an indulgent, “big operator” syndrome one comes across all-too-often in the hedge fund industry.

Those investors that didn’t want to look under the hood are ruing their decision yet again. I’m beginning to think the difference between the hares and the tortoises in the marketplace for alpha are immutable and fundamental. Beware the hare.

Alright, OK, I committed the cardinal sin of book reviews by blowing my load in the title.  And no, don’t read too much into this loved-up metaphor–I don’t really want to bugger Alexander Ineichen.  However, I do want to say a few words about his 2007 book, “Asymmetric Returns: The Future of Active Asset Management,” which, as you know, Dear Reader, pleased me to no end.

Perhaps the best thing I can say about the book, which is a sequel of sorts to 2003′s “Absolute Returns: The Risk and Opportunities of Hedge Fund Investing,” is that it 1) takes a distinct position on structural changes in the asset management industry (“this time it’s different”) AND 2) survives the 2008-2009 financial Armageddon with its thesis fully intact.  This in itself is a tremendous achievement.

In addition, I have never been so delighted by slightly-off-topic digressions and footnote-hidden chestnuts as I have by the ones in this book.  Perhaps it’s just the philosophy/geek in me speaking, but anyone who drops knowledge from Heraclitus, Kant, Wilde, Nietzsche, Popper, Kuhn, Twain and Roddenberry alongside that of Buffett, Soros, Thaler and Mandelbrot, is just playing in a different league than the usual technocrats & philistines that populate this particular genre of finance writing.  It’s always good to see a broader appreciation for and understanding of the sweep of history brought to bear on our present moment.

As for the meat of the content, Mr. Ineichen firmly backs the development of a next generation of asset managers who adapt dynamically to the marketplace, focusing on taking on positions with asymmetric risk-reward profiles.  Taking a rich and complex monograph of 336 pages and forcing it into the mold of a blunt instrument (if I may), Ineichen’s key insight is that downside volatility matters to long-term wealth creation.

Much of finance appears not to want to confront this reality, but an acceptance of it by the majority of investors would indeed constitute a revolutionary development in the asset management industry.  Anyone in the business of delivering risk premia would get paid peanuts, and anyone in the business of managing total risk (successfully) would be remunerated as handsomely as his or her society would allow.  In theory, then, Ineichen’s “unbounded hero” is the global macro manager–that manager with the fewest economic constraints on his or her investment activities.

What the book does not elaborate on, however, is on principal/agent issues and aligning incentives in the realm of asset management.  If there is one thing that we learned from 2008-2009 in hedge fund land, it is that in many cases, whether out of sheer self-preservation or a misunderstanding about whose money was actually being managed, hedge fund managers too often withheld investor capital.  Aside from this abject failure of fiduciary duty in the face of extreme volatility, even in a steady-state scenario it is far too easy for these masters of the universe to game their investors by neglecting the spirit of the investment management agreements they sign.

Whether the investors are actually to blame through their own complacency or worse is beside the point.  It’s time hedge fund managers shouldered the responsibility their exalted status confers upon them.  We don’t look highly on a society whose parents eat their own children in times of stress, do we?  Well, where’s your civility, Mr. Hedge Fund Manager?

Update: If this review didn’t make you hip to Mr. Ineichen’s unconventional style, his latest missive in the form of a Socratic dialogue featuring “Winnie-the-Bear” might do the trick.  Keep surprising us, Herr Ineichen.