Thursday, August 30, 2007

Absolute Returns Funds Conference Melbourne 23 August 2007

Investment&technology magazine held a well-attended absolute returns conference in Melbourne focusing on investment strategies for the future. Endorsed by AIMA, it had a strong educational bent. Almost half the 200+ attendees were investors, particlarly superannuation funds.

The conference attracted a number of US speakers including Gregor Andrade (AQR Capital Management), Andrew Dempsey (Fortress Investment Group) and Ron Insana (Insana Capital) of CNBC fame.

The conference was held against the backdrop of heightened volatility associated with the fall-out from the sub-prime mortgage collapse in the US. Earlier in the week, former Bankers Trust CEO Rob Ferguson was quoted as saying "the current market turmoil was very unusual because the securitised loans at the heart of the problem were rarely traded and valued in a discretionary way, making it easier for investment managers to obfuscate and delay reporting losses". See also an earlier entry on this blog titled "Are Australian Hedge Funds Risky?" Ferguson went on to say that "This is like a market event where the bodies are washing up on the beach gradually."

While the topic was addresed specifically in the session "New-style bonds: the risk and the rewards", Richard Borysiewicz (Credit Agricole Asset Management) and Andrew Howard (Mercer Global Investments) played down the likely impact on the real economy and the long-term impact on financial markets more broadly. Ron Insana described the use of derivatives and leverage as providing the "transmission wires for risk". While the credit disruption occured in one very specific market, the development and distribution of invesment product meant that the investment risk was widely dispersed. Graeme Miller from (Watson Wyatt) was concerned that in such extreme events, correlations are not stable and true risk diversification may not be achieved.

In a piece of exquisite timing AIMA Australia had earlier in the week launched its updated Risk Disclosure Guidelines for Australian Hedge Funds. While clearly the guidelines themselves would not have reduced the risk of recent events, it is an important guide for fund promoters to help ensure that the risks involved in hedge funds, as with any managed fund, are properly presented.

Amongst the breakout sessions, the two speakers presenting on the increasingly popular 130:30 sessions rated best - Gregor Andrade (AQR Capital Management) and Locheiel Crafter (State Street Global Advisers). For many investors at the Conference 130:30 provide a first step towards true alternative investing; while they don't offer any downside protection, the introduction of short selling potentially improves the information ratio compared with long-only investing. Such funds will have the effect of amplifying the alpha generating capacity of a manager; it won't help if the alpha generating ability is not there in the first place.

Discussion of 130:30 funds skates over the very important differences between investing and short selling. There is no guarantee that a manager skilled in long investing will also be successful in short selling, where research coverage is generally poorer and the maths works very differently. For example, an investment that performs badly reduces in size and risk, whereas a short sale that performs unexpectedly well will increase in size and risk. 130:30 funds are a structure not a strategy. If the manager is skilled at short selling a superior strategy would be to allow the manager more flexibility to short sell rather than adopt a fixed weight short selling of 30% ie a hedge fund mandate.

There was active discussion about fees in The Great Fee Debate. Jon Glass (FinAnswers) questions the alignment that relatively high base fees imply between manager and investors. He felt base fees should be lower. Tim Hughes the CIO (Catholic Super) was "outraged" at the high fees in private equity in particular. As a result, Catholic Super have made no private equity investments. He acknowledged though that it is a commercial matter and high fees were being tolerated. John Nolan (JANA Asset Consultants) delivered ten points on fees - the main one being that it is the ability to produce sustained investment returns that is most important, not fees.