Performance Perspectives
2009 saw investors raise the bar on hedge fund managers. After experiencing a rocky year in 2008, some investors waited months before beginning to research managers for new investments. When they did, they performed more due diligence than in the past and scrutinized managers’ operational and risk management practices.
Investors also dissected funds’ returns in deciding whether or not to hire managers, although some gave this more weight than others. BHA analysts always ask investors if they have strict return expectations for their searches. In 2009, analysts also probed to determine the importance of managers’ 2008 performance. The BHA team received responses across the spectrum.
Some investors refuse to consider a fund that had negative performance numbers in 2008. For this audience, a fund’s negative performance signaled an inability to react and adapt as markets moved against it. Such investors regularly cite a fund’s lack of effective risk management controls as a reason for disqualifying them from their search. An investment consultant based in the U.K. had such an outlook. This firm will consider only managers that have had positive years for the life of their funds. It believes that an occasional monthly drawdown over the years is acceptable, but that they should be relatively low and be outweighed by the positive months.
Other investors said that 2008 was an anomaly; a manager’s 2008 performance is not an accurate barometer of its ability to make money going forward. These investors believe that one year’s performance is not a good indication of a manager’s skill. A small family office in New York shares this viewpoint. The firm manages an in-house fund of hedge funds and takes an opportunistic approach when evaluating funds. It does not rule out managers based solely on their performance and understands that certain markets were hit harder than others over the past few years.
Finally, there were investors that fell somewhere in the middle of the two extremes. They were open to working with managers whose returns were down in 2008, but they established a maximum threshold. For example, they determined that managers could be down 15 to 20 percent but no more. For these investors, which made up the majority, returns seemed to reflect a mix of manager skill and market conditions.
Moving into 2010, investors will continue to weigh the significance of the past few years’ returns. 2009 was a great year for certain strategies, allowing managers to make up for their difficulties in 2008. But there will always be investors that want to invest in strategies providing consistent if modest positive returns year after year despite market fluctuations. Conversely, there will also be investors that don’t mind experiencing an occasional drawdown as long as the fund is able to hit its fair share of home-runs. It will be interesting to see if 2010 causes any shifts in investor sentiment.