Every Time a Bell Rings… Should You Cut Your Hedge Exposure?

MBMG IA’s Paul Gambles recently participated as an expert panellist at the Hubbis Digital Dialogue Series event on Hedge Funds and their Role in Private Client Portfolios Today.

He highlighted the diverse potential within the hedge fund universe, emphasizing that with the right approach, hedge funds can cater to a wide range of investor needs.

“While many wealth managers aim to maximise returns by preferring newer managers, our bias at MBMG IA is aligned with our clients’ expectations that we focus on managers with more of a capital preservation profile rather than a maximum potential return profile. Despite this, we have successfully advised investments historically into some newer, smaller managers.” Paul Gambles

Note: The transcript has been edited for clarity and enhanced reader engagement.

Understanding Hedge Fund Strategies:
While many wealth managers aim to maximize returns by preferring newer managers, our bias at MBMG IA aligns with our clients’ expectations of focusing on managers with a capital preservation profile rather than a maximum potential return profile. Despite this, we have successfully advised investments historically into some newer, smaller managers.

The Case of Kerrisdale Capital:
Paul cited the example of Kerrisdale Capital, a hedge fund that became prominent through MBMG IA’s statistical and qualitative analysis following the GFC. Their use of credit analysis to generate successful short ideas provided them with a distinct investing edge, demonstrating the capability to generate additional risk-adjusted returns. This deeper analysis, including a visit to their New York base, cemented our level of comfort with their approach. Kerrisdale has since become a significant success story, well-known for its activism and campaigns.

Focus on Established Managers:
The majority of our advice focuses on established managers, with whom we’ve had relationships for many years. This still requires ongoing due diligence. Successful performance of managers or funds over many years does not remove the obligation to monitor ongoing performance, consistency of approach, adaptability to changing demands, and continued discipline to ensure compatibility with our client portfolios.

Transition and Consistency – SAC to Point72:
Paul discussed the transition from SAC to become Point72, emphasizing the importance of ensuring that post-transition operations remain consistent with their history, heritage, and DNA. The complex nature of hedge fund analysis requires understanding which strategies work best in different parts of the cycle and which aim to work throughout the cycle.

Specialized Markets and Risk Evaluation:
Reflecting on past advisories, Paul highlighted the unique risks in specialized markets, cautioning against ventures into obscure sectors without comprehensive risk evaluation. For example, the French hedge fund market’s specialization in arbitraging obscure credit markets led to high-profile failures, underscoring the need to understand market nuances and expect potential pitfalls.

Relationships with Independent Advisors:
Paul explained that hedge funds often prefer relationships with independent advisors like MBMG Investment Advisory and our High Net Worth and family office clients over private banks. The transactional nature of private banks can lead to a focus on ‘flavour of the month’ investing, which is less sustainable compared to long-term relationships with independent advisors.

Hedge Funds vs. Traditional Investments:
Investing in hedge funds can be risky, but Paul noted that it’s often easier to make mistakes in traditional, directional capital market assets like long-only equities. Hedge fund investing, with its long-short strategies, can mitigate some of these risks.

Performance and Risk Management:
Paul explained his preference for hedge funds that work across the cycle, removing execution risk associated with timing cycles with specific strategies. He also discussed the difficulty of disentangling Alpha (value added by the manager) from Beta (value derived from the market) during booming markets. Hedge fund selection should be based on clear risk criteria, discipline, and adherence to fund objectives.

Comparative Performance Analysis:
Paul illustrated his points with comparative performance charts:

• Chart One: Performance of the Dow Jones Industrials since 2000, showing over 330% returns despite setbacks.
• Chart Two: Performance comparison of the Dow to Warren Buffett’s Berkshire Hathaway, which generated returns of 720% over the same period.
• Chart Three: Performance comparison including Point72 and Millennium, (two of MBMG IA’s advised) showing reduced volatility and increased returns of hedge funds compared to Berkshire Hathaway.

Despite the evident benefits, many investors still believe Berkshire Hathaway offers higher returns at lower risk than hedge funds.

Conclusion:
Understanding and due diligence are key to successful hedge fund investing. Hedge funds, with their diverse strategies and potential for risk-adjusted returns, can play a crucial role in private client portfolios. However, it is essential to carefully evaluate each fund’s strategy, market cycle compatibility, and the manager’s consistency and discipline.