130/30 “Hedge Funds”: Asset Gathering, Not Alpha Generating

I’ve remained silent for some time about this latest marketing tool engineered to separate people from their money. And we know it’s all about the money, right? Or is it about alpha? Hmm, I’m not sure. Anyway,  it’s not that there is anything inherently wrong with running a (hedge) fund - call it what you will - 130 long and 30 short, it’s just that calling it “revolutionary” or “new” is silly beyond belief. And yesterday’s blurb (I guess it is yesterday since it is 12:23am NYT at present) in the New York Times just pushed me over the edge; “Hedging Hedge Funds.” Are you kidding me? “Hedge Funds and Adverse Selection” is more like it.

Can someone, anyone, please tell me what the big deal is here? Is it a mutual fund with a limited ability to go short and use a little leverage to amplify the risk/reward profile of the fund’s bets? Or is it a hedge fund with an unusually restrictive document? Basically, it is the worst of all worlds, IMHO. Neither fish nor fowl. If the manager is really great at picking shorts, which is really the hardest part of the long/short game, then why would they choose to play in a pool that is limited to being only 30 short? Answer: they wouldn’t. They would go to a place where they could use their shorting skill to its fullest, namely, in a real hedge fund, not some bastardized, watered-down version. So, basically we’re talking about adverse selection in action.

Conversely, what of the skilled long-only manager who wants to try his/her hand at shorting to add a little spice to life (not to mention the ability to garner premium fees)? Buyer beware: this is a train wreck waiting to happen. The road is littered with managers who had strong returns in the long-only modality who tried to switch to a hedge fund that entailed shorting and got totally smoked. Why? The risk management principles (position sizing, number of bets, stops, liquidity, etc.) are fundamentally different on the short side than on the long side. There is no shame in not having this skill, but don’t pretend that you can simply acquire it because you are a good long investor. Shorting is a different game - a dangerous game - that needs to be learned over time. Otherwise, you’d better have some strong glue at your disposal since it is almost certain that you’re going to get your face ripped off.

So what is the deal with 130/30 structures? Why are they all the rage? Well, because of their limited ability to short, they have much greater capacity than true hedge funds and can grow to a much larger scale. What is good for the asset manager is not so good for the investor, you see. Charge hedge fund-like fees, have greater capacity, yet have it operated by B-type managers as those are the only ones who would willingly agree to such portfolio constraints. This is everything that is wrong with the asset management game, when the push is for asset gathering and not true alpha generation. Simply giving a broader array of investors access to a hedge fund-type vehicle doesn’t make it good; it makes it good marketing. And good marketing does not make for good investing. And if I’ve said it once I’ve said it a thousand times: caveat emptor. Because being a hedge fund-lite investor isn’t as sexy as you think.

——-

——-

COMMENT:

AUTHOR: Yaser Anwar

EMAIL: yaser@yaseranwar.com

URL: http://www.yaseranwar.com

DATE: 05/08/2007 06:39:19 AM

One more sign of the impeding  Hedge Fund bubble, fueled by the current bull market and a previously discussed topic, LDI aka Pension Funds. 

This reminds me so much of the 90s era when Global Macro funds were the norm, people would look at PTJ, Soros, Tiger and try to emulate them, but by 2000 when Tiger and Soros shut down their main funds, in Tiger’s case totally, it was doom and gloom. Nobody wanted to hear the term global macro. Ironically, since then they have done quite well on the heels of SAC’s macro division, Clarium Capital, Stan Druckenmiller’s D.Capital etc. 

A good portion of the current uptrend has been due to excessive short-interest. These guys forget the golden rule of shorting, “NEVER SHORT PURELY ON VALUATION!”- Julian Robertson. 

You should look at it the way I do- the more twats aka B-class and third-tier managers and closed-end funds listed worldwide, the more food for the wolves when the dust clears. Similar to MBS/ABX trend.

Hats off to the market departments. They’ve found a way, through 130/30 gimmickery, a way to the retail masses, which can potentially be as big, if not bigger, than the HNW clients (just look at the AUMs of the Vanguards and Fidelities of the world).

——-

COMMENT:

AUTHOR: j bogle

EMAIL: jboglejr@gmail.com

URL: 

DATE: 05/08/2007 09:33:43 AM

I understand your skepticism of these strategies, and agree, to a point, that they are dangerous when managed by those coming from the world of long-only.  I disagree, however, that they will charge full-freight “hedge fund fees.”  My observation is that for 30% of the alpha of a fully long/short strategy, the manager will charge something like 30% of the normal fixed fee, or 30 to 60bp.  Stands to reason as the assets in 130/30 will absorb only 30% of a manager’s capacity.  The performance fee at 20% is fine as it’s only on, of course, performance.  And i also disagree that these funds are marketed only by greedy managers (btw, I might be a greedy manager, but do not manage these strategies).  I think that most of the market here is driven by the demand side on the part of institutions that are too timid to be more exposed to a manager’s long/short alpha, and view these strategies as a lower risk way to get a toe in the alternative water.  It is a bit silly, but if that’s what makes them feel more secure, so be it.

——-

COMMENT:

AUTHOR: Chris

EMAIL: chuff@ha80.net

URL: 

DATE: 05/08/2007 09:35:28 AM

Nice post.

There are some interesting  models for the 130/30 fund that involve tax harvesting. Do you believe this stance adds any merit to the 130/30 “product”?

——-

COMMENT:

AUTHOR: Roger

EMAIL: roger@monitor110.com

URL: http://www.informationarbitrage.com

DATE: 05/08/2007 10:05:14 AM

Jbogle, I fundamentally agree with your comment. I didn’t think a 130/30 fund would charge full hedge fund fees, but thanks for the clarification. The fees charged ARE premium, however. 

My biggest issue is that an institution should be separating their hedge fund decision and their long-only decision, quantifying their risk budget, picking the best-of-breed managers in each domain (long/short and long-only) and allocating assets accordingly. In my opinion they are not relieved of their fiduciary duty by by allocating to a 130/30 fund, and to do so is an abrogation of their true responsibility to investors.

I do think that you will get adverse selection by the nature of the 130/30 construct for the reasons mentioned above, without a doubt. But I also agree with you that not all those offering 130/30 funds are greedy bastards. Only some of them are. Thanks for the insightful and intelligent comment.

——-

COMMENT:

AUTHOR: Brian

EMAIL: B@sw.net

URL: 

DATE: 05/08/2007 07:51:28 PM

Most of the 130-30 managers are quants, who already evaluate all stocks, both attractive or unattractive, with their models.  And most already run products with 100% shorting.  The 130-30 fees actually aren’t all that high, but the demand from clients is quite large.  And now, so is the supply from a host of successful quant managers.  It certainly is fair to ask if the 130-30 buzz is overdone.  But your far-out proclamations illustrate your lack of familiarity with the quant equity players dominating this space.

——-

COMMENT:

AUTHOR: Roger

EMAIL: rogere@nyc.rr.com

URL: http://www.informationarbitrage.com

DATE: 05/08/2007 08:11:42 PM

Brian, fair point. According to a recent article  in Pension & Investments (http://www.pionline.com/apps/pbcs.dll/article?AID=/20070416/PRINTSUB/70413043/1031/PIIssueAlert01&template=printart), approximately 80% of 130/30 funds are run by quants. That said, I still don’t buy the argument for 130/30 funds in general. I think it is really an issue of asset allocation more than some hybrid fund. I would rather have a mix of a top performing manager’s long/short fund and long-only fund than a 130/30 mix that has me locked into this particular allocation. It imposes a level of rigidity that seems both unnatural and unnecessary. And it is a marketing game, to be sure. But thanks for setting me straight on the composition of the current providers, Brian. That was a really helpful comment.

——-

COMMENT:

AUTHOR: Cole Wilcox

EMAIL: cole@blackstarfunds.com

URL: 

DATE: 05/12/2007 07:04:06 PM

The 130/30 is a valid concept if you are boxed in by certain traditional asset allocation decision making constraints. 130/30 allows a manager to deliver a 100% net long exposure profile and the “alpha” should be benchmarked vs. the manager’s traditional style group index benchmark. If you run a 130/30 small cap portfolio and you deliver higher returns with less volatility vs. the Russell 2000 then you are delivering Alpha. My argument is that a traditional, unconstrained long short hedge fund is not the correct benchmark for a 130/30 fund since its net exposure is 100% long just like a traditional beta index. 130/30 is really a traditional manager with a sexy  ìhedge fundî wrapper. The fees on a 130/30 fund that delivers alpha should not exceed the fees that one would pay a traditional long only manager that produced the same risk adjusted Alpha without shorting. Renaissance Technologies, manager of the famed Medallion Fund now offers the Renaissance Institutional Equities Fund (REIF) which is a 130/30 like structure (itís allowed to float between 130/30 and 175/75) maintaining a 100% net long exposure. The fund offers multiple fee options but they all average the same over time, which is about a 2% annual management fee. This fund carries a 20 million dollar minimum and has raised over 20 billion dollars in the first 24 months of operation. My point is that fees over 2% for a 130/30 fund are not in line with established market benchmarks since you are really buying a traditional net long portfolio. I personally like the 130/30 strategy, as it a more efficient way to make a long only investment and delivers alpha that comes from portfolio management not stock picking. That said, as a long only portfolio 130/30 it is not a hedge fund and its structure does not allow enough alpha to be produced that you can command 2 & 20 fees. But, in my opinion there are very few if any funds, which are open to new investment, that that are worth 2&20. The whole hedge fund industry has become a marketing machine to create products that suck in new investors to overpay for investment management services. Iím not saying that there are no firms generating returns, just that they will not take your money since anything worth paying for has limited capacity and the manager keeps this for their own money. Renaissance is a perfect example, their 5 Billion Medallion Fund has no clients left and had been closed for over a decade. The compounding and reinvestment of profits alone sucks up all capacity that may be generated from further research and development opportunities. These guys have to run just to stay in place, and they donít need or want your capital. Alpha is finite and not available to all investors, but the hedge fund industry has become such a marketing machine that it makes it seem like there are gold bars just laying around and if you pay them 2 & 20 they will pick them up for you. In my opinion the hedge fund industry has become overrun by an intellectual fraud. A rotating ferris wheel of survivorship bias and marketing puffery.  

——-

COMMENT:

AUTHOR: Eclectic Contrarian

EMAIL: econtrarian999@gmail.com

URL: 

DATE: 07/09/2007 12:59:24 PM

I’m interested to hear what the fee structures are at RIEF — does anyone know?  I’ve heard of 2 thus far — 50bps/10% of profits and ~200 bps.  I’ve heard a 3rd is linked to S&P outperformance.  Would appreciate any info.

——-

————

3 years ago | view comments |  Investing