It's 70 years this year since Alfred Winslow Jones first employed the investment strategy that would go on to become commonly known as a "hedge fund". Not only am I proud that the man referred to as the "godfather of hedge funds" is a fellow Australian, I am also fascinated by his much wider commercial legacy.
Jones' original fund charged performance related fees, provided for periodic redemptions and used leverage and shorting as part of its investment strategy.
Over the last decade hedge funds have gone onto become part of popular culture, so much so that their internal machinations make for prime time viewing (or holiday season box set binging) these days. The public perception in 2019, is that they are simply a series of high stakes bets on everything and anything. Any truth in that? The use of the term "hedge funds" has become increasingly misused and abused. Most of what are commonly thought of today as being "hedge funds" are in fact nothing of the sort and are often nothing more than a naked directional bet. Unsurprisingly, when these bets don't come off, investors and the media are quick to bemoan the poor returns. The problem here is that if you start by equating the investment process of a hedge fund to gambling, you can only see a binary outcome – either you win or you lose your money. The risk/reward analysis and the horizon in which it operates change fundamentally.
There is a risk that much of the commentary about poor returns and increasing redemptions sets out from this start point.
Taking a slightly more academic, some would say purist, approach here might prove helpful in moderating the debate around the poor performance of hedge funds. The hedge funds of Jones' day were seen as risk managed investments, which assumed that there would be periods of drawdown and that the fund manager's skill lay just as much in navigating these periods, as it did in producing stellar returns.
Have investors completely abandoned the notion of hedge funds as a risk managed investment in favour of out and out performance? It seems one bad year has left some investors contemplating whether there is a place for hedge funds at all in their portfolio. We may find out in 2019, should we see continuing geo-political instability, market dislocations or, heaven forbid, miscalculations in asset pricing.
Investors would do well to remember that although hedge funds didn't completely protect against losses in the last bear market, many did fare better than the commonly used index benchmarks. There is a tactical, risk management benefit being overlooked amongst the rush to crucify the industry over poor performance. 2018 showed us that hedge funds, like most things, come in all shapes, sizes and varieties. Lumping them all together into one basket for the sake of a good story may not be the best way to analyse them. In and amongst the fog, there were some rays of light: some global macro and quantitative funds produced strong returns.
2018 also showed us that despite suggestions to the contrary, at times of uncertainty investors seem to prefer size and longevity in their managers. Hence the flight to bigger, more established names. That doesn't necessarily lend itself to better returns either. Maybe this points to tough times ahead for emerging managers, who are often the source of innovation, fresh ideas and out-performance in turbulent markets? If our experience in 2018 is anything to go by, there are still high conviction investors in this market. They may just look a little different to what they used to and they may come from further afield, but they are out there and the money which continues to flow into alternative asset classes demonstrates this.
One thing is for sure, we are in for more turbulence ahead. Brexit, shutdowns, slowdowns, showdowns, geo-political dysfunction globally and the gradual unwinding of QE are a potentially potent mix. Is there a place for hedge funds in that environment? Alfred Winslow Jones would tell us there definitely is.
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