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Hedge Fund Managers: First Shot, Second Chances

By Teresa | Filed Under Trading Ideas | Start a Discussion 

30-hedge-fund-lawsuits-large.jpgI received feedback from the young would-be hedge fund manager who was not amused to be lumped in with the Beardstown Ladies, to which I replied that there is no such thing as bad publicity.

There is an odd paradox in fund management: it’s hard to get your first shot, but once you’re in, there seems to be no limit to how many times one can blow up and still land paying gigs.

Individual investors tend to have this infomercial-inspired idea that trading is a genteel, even relaxing vocation but the industry itself is nothing of the sort. It’s the most pure form of survival in the jungle I can think of. Anything that has to do with money — obscenely large amounts of it — is never, ever nice. It’s a blood sport. I was therefore interested in how someone trying to break into the business without the usual credentials planned to avoid the fates of Nobel Laureates. Unfortunately, we were unable to come to terms for an interview.

To get an idea of what really goes on, check out the predicament of my friend, fund manager Eric Falkenstein. And you thought you were having a bad day, eh?

Questions that Fund Managers Ask

One thing I’ve noticed is that individual investors tend to focus on performance and not much else. What would a fund manager look for in another fund manager? Well, that is exactly what I found out from four friends in the industry as I negotiated for the interview.

Comments from a 28 Year-Old Hedge Fund of Funds Manager:
I had to think of David Mobley and his Maricopa fund. He never went beyond vocational high school but told investors that he studied the stock market since he was 13 and claimed to have developed a software called Predator that was accurate 70% of the time in predicting stock market movements… Sure. After blowing up he pleaded guilty to charges of mail fraud, wire fraud and money laundering.

I’ve just returned from a 10-day trip to London. Besides interviewing a couple of single managers we are interested in, I also went to 3 hedge fund conferences (Credit Suisse, UBS, III Advisors). There are so many funds with a good track record (not back tested), large teams (50-100 years of combined experience in the market they are trading in), a bunch of good trading ideas and sound investment process, amazing education (University, Institutions they worked for), sound on the operational side (mid and back office, administrator, custodian, broker, IT, …)… so why should anybody invest with this guy?

Is he really doing stat arb (short term) or relative value (mid to long term)? Stat arb: Who wrote the software? Just price and momentum or some other factors? Average holding period? Risk Management? Stop-Loss? Concentration of portfolio? Trade implementation?

ad Global Macro: How many themes? Just long energy and praying?

Comments from a 40-something Hedge Fund Manager:
I’d hire a smart 20 year old. I wouldn’t give him money, though. To be fair, a 34 year old is mature enough to handle the bills and such, but clearly they are presenting the 20 year as a trading wunderkind, clearly thinking someone will think he’s some kind of young trading superstar. I would be interested in his focus:

  • Is his investment horizon generally what time frame: 1 day? 5 day? 1 year?
  • Is his edge based on quantitative methods? Would these be more like technical analysis, or statistical analysis? Or is it a mixture of this plus qualitative?
  • Given he has limited experience, what common toolset is he going to use to analyze global macro, statistical arbitrage, emerging markets, international equities, and commodities.
  • In what way does he think taking option positions, as opposed to merely futures, helps his edge.
  • Does he have contacts on the street that help his strategy? If so, how?
  • Does he have a special front-end trading platform that is unique? If so, how?

I think if he’s focused on something very narrow and quantitative, he could be the real deal. But if he seems to be asserting he trades everything, at all horizons, using all products, and qualitative information, I think he’s just a huckster. Most young traders who did real well were well connected (eg, Steinhardt), traded on the floor, or focused on one strategy that worked no matter who did it (Griffen and Converts in the 90’s).

Comments from a 26 Year-Old Former Fund Manager:
A 20y old rookie with a 34y old rookie - how much more inexperience is possible for a hedge fund? Does he also have unique investment ideas? From the webpost I can see that he is able to correctly recite the gossip of the FT and extrapolate a current trend. Stat arb and dropping out of college go hand in hand nowadays? Has the kid seen any interesting place in the world to be able to form a global macro view? Sorry, but that is not for me ;)

Comments from a 30-something Derivative Credit Risk Manager:
Funny, I did the back calc & I was just 20 when I started working for XXX in the mid-1990 - well, actually, XXX first…

And I had read a few books on trading so I thought it would be easy, you know, just set up my predictive neural network, make XXX some $$$ and keep 1/3 of it (that was the deal offered).

The hedge fund industry was pretty unknown at the time; we really only had Soros and the Mkt Wizards guys to look to. Thus, he’s probably not that different than I was, but he’s clearly got more chutzpah than I did.

If someone doesn’t want to talk about how the portfolio is managed, it probably means:

  1. I don’t want to make any predictions that will later come back to haunt me as I continue to struggle to raise money, or,
  2. I want to imply that I have some super-secret methods, which I can’t tell you about, but they’re really great, so trust me and hand over your money…

What I Would Have Asked

Geez, all I wanted to ask was how much leverage would be used. Notice not one single person asked about performance. I feel vindicated: Somebody call my former nanny and tell her Teresa was not crazy for always reading the label and not the price.

Second Chances, As Always

Vic Niederhoffer said it best, that it was tradition in America to give second chances. And third. And fourth…

  • Failed Sowood hedge fund manager raising new money
    One year after Jeffrey Larson lost about $1.5 billion in one of the hedge fund industry’s most spectacular collapses, he is trying to raise fresh capital for a new fund, people familiar with his plans said. “Larson is back and he has been calling virtually everyone in town, leaving no stone unturned,” said a Boston-based investor who was contacted by Larson but declined to be identified so he could speak candidly about the new fund.
  • Peloton investment chief plans new fund“Since the folding of Peloton in late February, I have been spending my time overseeing the orderly liquidation of the Peloton Multi-Strategy Fund and returning as much capital as possible to investors,” Mr Grant said. “At the same time I’ve known all the guys on the team I built for a long time. They want to stay with me and it would seem a shame not to give it our best shot to make that happen. I will join them on a full-time basis once the wind-down is complete.”
  • A Decade Later, John Meriwether Must Scramble Again
    Ten years after overseeing a hedge-fund collapse that buckled the world’s financial markets, John Meriwether again is scrambling to stem losses and keep investors from jumping ship. Mr. Meriwether is best known as a founder of Long-Term Capital Management, which in 1998 lost $4 billion. That helped foster a global financial crisis and triggered both a Wall Street-led bailout and congressional hearings on the dangers of hedge funds, the freewheeling pools for wealthy investors and institutions that often trade heavily and rely on borrowed money to bolster returns. Now, Mr. Meriwether’s biggest fund, a bond portfolio, has plunged 28% this year; another, broader market fund is down 6%. Both had subpar performances last year.
  • Meriwether’s Troubled Fund Ofers Early Exit
    Investors of the JMW Global Macro fund, the smaller of the two funds managed by Meriwether’s JMW Partners, are being offered the chance to pull out their money as soon as tomorrow, The Post has learned. Ordinarily, the fund’s investors would have to wait until the end of June to exit. Meanwhile, investors of Meriwether’s flagship fund - the $1 billion Relative Value Opportunity fund, which had losses of nearly 32 percent as of the end of March - are less fortunate. . . It isn’t clear how much money will be pulled from Global Macro at the end of this month, but unlike with Relative Value, investors can pull out as much as 100 percent of their stake in the roughly $400 million fund, which lost 14 percent through March.
  • Drake to Shut Its Largest Hedge Fund, Plans New Fund This Year
    Drake Management LLC, the New York- based firm started by former BlackRock Inc. money managers, is shutting its largest hedge fund, according to a letter to investors. It plans to start a new fund later this year. . . . “We are committed to launching successor vehicles for the funds later this year,” yesterday’s unsigned letter said, referring to the onshore and offshore versions of the Global Opportunities fund. Current clients who want to invest in the new fund won’t pay performance fees until their losses are recouped.
  • The $500 Billion Hedge Fund Fever
    [Editor: Article from 2001 provides background into the industry.]
    “I think it’s inconceivable that you could take $500 billion run by 6,000 different managers and expect these managers to be smarter than the rest of the world,” says Bogle. If the market is up 10%, he calculates, then hedge fund operators would need a 17% return to beat that–given a 20% carry, a 2% annual fee and taxes. “I don’t think that $500 billion has a remote chance of beating 17%.” So the point is to carefully choose a good hedge fund. And note this: Anybody can open one. “Every Tom, Dick and Harry is putting out a shingle,” laments Elizabeth Hilpman, a partner in Barlow Partners, a seven-year-old New York hedge fund of funds. “It’s become harder to tell the good managers from the bad.” No kidding. Paul Mozer, whose fast-and-loose bond trading landed him a prison term and almost tanked Salomon Brothers, is said to have started a hedge fund. And John Meriwether, a figure of widespread ignominy after Long-Term Capital collapsed, has simply launched a new hedge fund, JMW Partners.
  • Hedge Funds Make It Hard To Say Goodbye
    With the markets sputtering, some high-profile hedge funds are rejecting withdrawal requests, with some telling investors that it could be years before they will see all their cash again. And it isn’t just big institutions and the wealthy that are getting rebuffed. Some smaller investors who took advantage of lower minimum investments by putting their cash into so-called funds of funds, which invest in numerous hedge funds, are also getting blocked.
  • Equity hedge fund strategies show first outflows in six years
    Performance across equity hedge fund strategies fell 5.7% in the first quarter. Convertible arbitrage, emerging markets and technology-focused equity strategies fell over 6% in the same period. Several hedge funds froze redemptions in the first quarter in the wake of market volatility.
  • Need for good managers says Fitch
    At a briefing on the performance and outlook for asset managers and alternative asset classes, Aymeric Poizot, head of Fitch Ratings EMEA Fund and asset manager rating group, said managers with a solid understanding of market dynamics and hedge fund strategies will fare better than more static or reactive managers. He said returns will increasingly be sought in macro, relative value, arbitrage, trading or illiquid strategies. Managers with resources in these areas — like analysts, risk management tools and access to appropriate hedge funds — will have a competitive edge. Poizot highlighted the importance of proactive managers at a time when the risk of marked hedge fund underperformance has increased. He added capital allocation will be an important contributor to performance.
  • Hedge funds take extra risk to reach fee targets
    [Editor: But we already knew that from the annals of behaviorial finance, right?] Mr Motson and Andrew Clare, both of Cass Business School in London, and Chris Brooks of the University of Reading, analysed the Cass database of 2,800 hedge funds, which typically will be remunerated with a 20 per cent performance fee on top of an annual fee of 2 per cent of assets under management. They found that hedge funds that are “out of the money”, defined as trading at less than 95 per cent of their high water mark, at which a performance fee kicks in, exhibit a high level of risk-taking with a standard deviation, a measure of variability of returns, of 8.5 per cent. However, funds that are comfortably “in the money” and those that are close to their high water mark, termed “at the money”, exhibited much less volatility, with standard deviations of 6.4 per cent and 4.9 per cent respectively. “This surprised us a little bit,” said Mr Motson, a former trader at First National Bank of Chicago, Industrial Bank of Japan and head of London trading at Wachovia. “It does appear that as managers go below their high water mark they increase risk.”
  • Lure of City money too strong for young, says Mervyn King
    “I do think it is rather unattractive that so many young people, when contemplating careers, look at the compensation packages available in the City and think that these dominate almost any other type of career. “It’s not a very attractive situation that such a high proportion of our talented young people naturally look at City and think it is the only place to work in. It shouldn’t be. It should be one of the places, but not the only one,” King told the Treasury select committee.
  • Jerome Kerviel Takes A Career Detour
    Jerome Kerviel is finally adding an extra line to his résumé, just above “world-famous rogue trader at Societe Generale.” Kerviel is now two weeks into a new job at information technology consulting firm LCA, which is based just outside Paris. The manager of LCA, Jean-Raymond Lemaire, confirmed that Kerviel was still being trained for the position, but he declined to comment further.

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