Fish, a near-death experience and other notes from Boston

22 Oct 2009

btownBOSTON – One of the themes discussed by alternative investment industry bigwigs at this week’s Global Absolute Return Congress in Boston was the future of the funds of funds sector.  One of the sessions on the agenda was called “Funds of funds are dead.  Long live funds of funds.”

That turned out to be quite a prescient title.  HFR released its Q3 run-down of asset flows into and out of the hedge fund industry.  The firm found that…

“Investors continued to withdraw assets from funds of hedge funds during 3Q, but at a reduced rate. Fund of fund redemptions totaled only $3.2 billion in 3Q, compared to a cumulative withdrawal of more than $180 billion in the previous four quarters. In contrast to single-manager strategies, over 73 percent of all fund of funds experienced net outflows for the quarter.”

This seems to suggest that, in this post Madoff environment, funds of funds are only just dying more slowly than before – but that they are dying nonetheless.  In fact, Dow Jones ran a story on Wednesday titled “Investors favour direct route to hedge funds’ doors” in which it referenced investors’ “growing predilection for placing their cash directly with managers.

But wait!  Research firm Brightonhouse Associates found that Q3 marked a turning point and suggests that funds of funds may live a long and happy life after all.  That company’s Q3 analysis finds that,

“2009 has proved to be the year of the bounce-back for the fund of funds industry. In the third quarter, both managers and investors expressed high levels of optimism and confidence in funds of funds. This was reflected in the HFRI Fund of Funds Composite Index, which showed fund of fund performance increased 1.13 percent in the month of August, and 8.03 percent year to date. Additionally, during the quarter, BHA analysts spoke with more than 140 investors that voiced an interest in hearing from funds of funds for research and due diligence purposes. This number represents nearly a 20 percent increase over the first quarter when many investors were much more skeptical of funds of funds across the board.”

So there you go.  Funds of funds are dead.  Long live funds of funds!

Time to move out?

While we’re on the topic of Boston…

Although we aren’t allowed to report on the specific proceedings of the Global ARC, there were several sessions involving other news makers in attendance.  For example, The New York Times ran this front page article on Paul Volker the day he addressed the gathering here in Beantown.

The Times reports that Volker…

“…wants the nation’s banks to be prohibited from owning and trading risky securities, the very practice that got the biggest ones into deep trouble in 2008. And the administration is saying no, it will not separate commercial banking from investment operations.”

In general, the audience here seemed somewhat sanguine about the possibility of some kind of Glass-Steagel II – choosing instead to focus on the immediate investment opportunities before them.  In fact, the audience made up of hedge fund managers, institutional investors and “quants” from both groups actually applauded when Volker called on universities to produce more civil engineers and less financial engineers.

A remarkable show of unity between investors and managers?  Perhaps.  But what surprised us a little more was the apparent common ground shared by the hedge fund community and left-of-center thought leaders such as Joe Stiglitz, Paul Volker, and Niall Ferguson – none of whom minced words when it came to their opinions on the causes of (and solutions to) the financial crisis.  One hedge fund manager summed it up Volker’s commentary as “holding up a mirror to the industry.”

Koo and the Gang

Richard Koo, author and Chief Economist of the Nomura Research Institute in Japan has the ears of various leaders around the world.  He has become the spokesman for a school of thought that believes deficit spending is critical in a “balance sheet recession” like the one we’re in right now.  Drawing on the Japanese experience during the “lost decade”, he argued that inflation should not be a concern since government debt is just filling the gap left behind by suddenly-thrifty US consumers.  He warned the audience not to assume that the US is continuing it’s spendthrift ways.  In fact, he noted, the US savings rate is now higher than Japan’s.

Regular readers will remember his remarks at Global ARC in San Francisco in the spring when he said that debt must migrate from private balance sheets to public ones since only governments have the ability to avoid the paradox of thrift.

Teach a Man to Fish

One of the most popular sessions here was probably one that compared biological processes to financial ones.  One of the speakers, Andrew Haldane, Executive Director of Financial Stability delivered a fascinating speech earlier this year on the topic of systemic risk.  Some have called it one of the best speeches ever written on the topic.  In the text of that speech, Haldane draws on natural science and diseases for lessons on how to contain financial contagion.

Two of the other panelists, Lord Robert May of Oxford and George Sugihara of the University of California, co-wrote this article in Nature called “Complex systems: Ecology for bankers” (with Simon Levine of Princeton).  In it, they discussed the credit crisis in the following terms:

“An analogous situation exists within fisheries management. For the past half-century, investments in fisheries science have focused on management on a species-by-species basis (analogous to single-firm risk analysis). Especially with collapses of some major fisheries, however, this approach is giving way to the view that such models may be fundamentally incomplete, and that the wider ecosystem and environmental context (by analogy, the full banking and market system) are required for informed decision-making. It is an example of a trend in many areas of applied science acknowledging the need for a larger-system perspective.”

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