The debate over short selling often pits traditional “long-only” managers against the upstart alternatives: hedge funds.  But as this report in today’s FT points out, the lines between “traditional” and “alternative” are blurring quickly.  The Alternative Investment Management Association (AIMA) has been an ardent defender of the hedge fund industry against what it sees as unfair criticisms in the media (see related posts).  But now associations of “traditional” investment managers have come to the defense of short-selling.  In fact, according to the FT, the Investment Company Institute (ICI) in the US, the Investment Management Association of the UK (IMA), and Australia’s Investment and Financial Services Association (IFSA) have each waned regulators against requiring short-sellers to publicly reveal their short positions.

The head of the IFSA tells the FT:

“The clients of fund managers and mutual funds pay the fund manger for their services and they don’t pay for their services so others can have access to what they are doing…”

Why would organizations of non-hedge funds advocate for something that seems to benefit only hedge funds?  Apparently because many of their members believe shorting is a good idea.  The fact is that short-selling is simply a strategy.  Hedge funds, it is often said, are a legal structure - not a strategy.  The FT seems to suggest that a hedge fund strategy such as, for example, a long/short strategy, is not necessarily synonymous with a hedge fund at all

In November, Thomas Donaldson, a professor of legal studies and ethics at Wharton gave a talk on “hedge fund ethics” during which he argued that hedge fund regulation was beset with several fundamental problems.  Chief among them was what he called “regulatory recalcitrance” - the fact that hedge fund regulations were often at odds with the very rationale for hedge funds.  According to the website “Knowledge @Wharton” Donaldson said:

“I want to suggest that there is something to the idea that smart people can create novel strategies, and that this is something to be protected. This is a social good…I do not want to prevent capitalistic acts between consenting adults.”

According to the account of his talk, Donaldson is certainly no fan of hedge funds.  Yet he, like the (traditional) fund associations listed above, see value in some form of less-than-full transparency.

In his Congressional testimony on hedge funds’ role in the financial crisis, Houman Shadab of George Mason University made the following important distinction:

“Given the complexity of the issues involved in this inquiry, it is helpful to make the following distinctions to clarify the difference between financial institutions, instruments and activities.

• Financial institutions include banks, investment funds, insurance companies, and
  broker-dealers.
• Financial instruments include securities such as bonds and collateralized debt
  obligations derivatives such as options and credit default swaps.
• Financial activities like using leverage and short-selling.”

Using Shadab’s rubric, short-selling is an activity that is performed by many different institutions (hedge funds, long only funds, pension funds, insurance companies) and using many different instruments.  In that sense, it’s no surprise that hedge funds aren’t the only ones coming to the defence of short selling.

Optimistic analysts and economic commentators are apt to interpret a downturn as a “cyclical bear in a secular bull market”.  It seems that this phrase can also describe the current state of the the hedge fund job market.  Few question that last year was an annus horribilis for the hedge fund industry.  But Euromoney reports on a survey conducted last summer by the website Hedge Fund Jobs Digest that reached a number of surprisingly rosy conclusions.  The president of Hedge Fund Jobs Digest tells Euromoney that despite the turbulence, “There is still a strong flow of private equity and hedge fund hiring.”

Bear in mind that the survey was conducted pre-Madoff and prior to drawdowns experienced by so many hedge funds in the second half of 2008.  But it’s still interesting to note that hedge fund career opportunities went into the second half with a considerable amount of momentum.

In fact, satisfaction with hedge fund job compensation rose from 25% to 42% last year and the hours worked by a typical employee remained pretty tame as the chart from the survey below indicates:

With an average total compensation of around US$250,000, that’s about US$85 an hour.  Not bad.  But what’s kind of surprising is that those employees with an MBA made marginally less than those without an MBA - and they get more vacation.

The significantly higher bonus suggests one of the likely causes for this phenomenon: Highly-bonused positions seem to be populated by non-MBAs.

In any case, about half of hedge fund compensation seems to come from discretionary bonus and half from salary.  So when revenue gets cut in half, what happens?  Compensation is by far the largest expense faced by hedge funds.  So a fall in AUM would likely impact overall compensation expense commensurately.  As IDD Magazine reported in December:

“Hedge funds, which have long attracted Wall Street professionals with the promise of hefty salaries and bonuses, are now cutting staff in an effort to reduce expenses.

Much of the overhead a hedge fund has is related to salaries. So, if assets under management drop 50% due to a combination of redemptions and negative returns, these firms cannot support the same overhead.”

If hedge fund managers “can’t support the same overhead”, then managers must look at layoffs in order to maintain some level of bonus for remaining employees.  Some of the calculus that goes into this trade-off (between reduced bonuses and lay-offs) was contained in an interesting report we mentioned last month (see post).  But if bonuses are reduced before heads in 2009, then the data above suggests non-MBAs may be more likely to see their compensation cut, while MBAs may be more likley to see their heads cut.

Hedge fund incentive fees are often called a “free option” since the fund manager can win, but can’t lose.  Since managers can influence the volatility of their funds, many assume that this asymmetry will always give the manager an incentive to “swing for the fences”.

But with so many hedge funds starting off 2009 well below where they were a year ago, we thought it might be useful to examine whether this axiom holds true in the existence of the ubiquitous high water mark.  Last year, two academic studies published before most hedge funds took a dive under water address the impact of high water marks on manager incentives and decision making.  Now is probably a good time to have a second look at them.

The first, by Stavros Panageas of the University of Chicago and Mark Westerfield of the University of Southern California, finds that high water marks mitigate the manager’s potential benefits from goosing their fund’s volatility.  The duo points out that the value of the manager’s “free option” is based on the extent to which the fund is below its high water mark (or, to use the option analogy, below its strike price).  So swinging for the fences and losing has a direct impact on the wealth of the manager.

In a real sense, the “free option” is actually an infinite series of future (annual) options, each with new strike prices in relation to the fund’s value.

In their words:

“A bolder portfolio today could help increase the probability of crossing the current high water mark, but it will also increase the probability that the assets in the fund will be substantially lower next period, while the high water mark will remain unchanged. In the latter case the value of future options will decline, as the assets in the fund will be lower for the same value of the high-water mark. Hence, future options will become more ‘out of the money’.”

So lower moneyness means less value in the option for the manager - an outcome than can make a manager think twice before pointing to center field and taking that Babe Ruth-sized swing for the fences.

While Panageas and Westerfield’s study assumes the hedge fund in question has an infinite life span, the second study, by Susan Christoffersen of McGill University and David Musto of Wharton, recognizes that as small businesses, hedge funds fold on a regular basis.  Thus, investors who are below the high water mark can be shut out of their well-earned performance fee holiday if the manager unilaterally calls it quits.  This can mitigate the negative effect of high water marks on the value of the managers’ “free option”.

Christoffersen and Musto also point out that high water marks can divide investors according to their  tenure in the fund.  As they write,

“…with a HWM, old investment invests on better terms after a loss, because it does not pay the incentive until the loss is made up, whereas new investment has no loss to make up, and therefore pays higher expected fees. So if expected profits after a loss are zero for new investment they must be positive for old investment.”

This is going to be a big issue in 2009.  Most investors are about to embark on a year-long performance fee holiday (which, as an aside, will likely drop the average cost of a hedge fund in 2009 to below that of many mutual funds).  But new investors - or even new assets from existing investors - will face a high water mark of the fund’s NAV on the day of their new investment.

With dramatically different pay-offs, it’s not a huge stretch to imagine potential infighting among hedge fund investors as new entrants pay markedly higher fees than old ones.  The problem is that these “new” investors might just be those who have redeemed from other funds and have reallocated back to the asset class in the form of a different fund.  Just as loyal investors face the frustration of watching their manager give up as a result of  being too far below the high water mark, many other investors will likely frustrate their own chances of success by switching horses - only to have their high water marks reset.

Critics of hedge funds often argue that industry growth has had two negative side-effects: firstly, that less-skilled managers have been attracted to the sector and second, that the number of alpha-generating opportunities has not kept pace with asset inflows.  Assuming these are true, then it could be argued that recent industry shrinkage may lead to new opportunities.  In our monthly guest contribution from a member of the Chartered Alternative Investment Analyst (CAIA) Association, Tommaso Sanzin of Hermes BPK Partners suggests that recent headwinds have ushered in a new phase in the “hedge fund industry life cycle”.  Sanzin is Partner and Head of Quantitative Research and Risk Analysis at Hermes BPK and was previously head of quantitative research at Pioneer Alternative Investment Management in London.  Hermes BPK is a boutique fund of funds majority-owned by British pension manager Hermes.

Alternative Viewpoints: Manager Capacity vs. Market Capacity: The fund of hedge fund conundrum

Special to AllAboutAlpha.com by: Tommaso Sanzin, CAIA, Partner & Head of Quantitative Research and Risk Analysis, Hermes BPK

In December, the National Bureau of Economic Research (NBER) announced that the U.S. economy entered the recession in December 2007, declaring the longest contraction since 1982. At the same time, early November reports estimated that the fund of hedge funds industry returned  negative 19% YTD, making it the worst and the longest drawdown on record, according to Chicago’s Hedge Fund Research (HFR). There is no doubt funds of funds are possibly facing the strongest headwind ever, as prices depreciate, liquidity conditions worsen and a tsunami of redemptions hits managers.

Clear and Present Danger

“Flow risk” can be defined as the risk that a manager experiences significant redemptions mostly due to industry-wide issues or a specific category of investors, rather than due to issues related to the manager itself. Among the current threats, this risk is probably the toughest to navigate. It can be exogenous to the portfolio and usually results in massive deleveraging that  impacts most managers, regardless of their performance or size, since both longs and shorts are indiscriminately squeezed and/or liquidated. This may seem obvious in the current environment but the summer ‘07 quantitative long/short managers debacle highlighted how a deleveraging event can hit hedge funds even if they run “neutral” portfolios and the equity market closes the month up (recall August 2007).

Liquidity or Objectives Mismatch?

The above mentioned flow risk is caused by a general liquidity mismatch between assets and liabilities caused by a deeper mismatch between clients and hedge fund managers objectives. The industry has always been broadly split into high net worth individuals and institutional long-term investors, with fund of hedge funds typically viewed as institutional investors. The issue has been that funds of funds raised money mostly through platforms or structured vehicles whose investors were predominantly private clients. These clients had a shorter term view than the funds of funds themselves and definitively had a much shorter one than the underlying managers (especially with regards to the less liquid strategies). Not only did they have different investment horizons but also different investment objectives. Private clients were looking for “optionality” in returns (equity like returns during bull and bond like returns during bear) while institutions generally aimed for low volatility and contained correlation against other asset classes. All this resulted in a conflict of objectives, which was very difficult to manage by funds of funds, thus creating the foundation for the current liquidity crisis.

Hedge Fund Evolution

Life below the ubiquitous “high water mark” has never been easy. Having said that, hedge fund survivors have always enjoyed periods of renaissance right after each previous crisis. It is likely that the overstretched bull environment attracted less skilled (on average) players in a very crowded (and thin) opportunity set, leading into the current crash which very few have been able to forecast. The good news is that market capacity is improving day by day and a new range of opportunities has arisen from the present dislocation. The winners will prove their skill and are likely to enjoy the panacea of rich trades and very little competition.

Where does the new set of opportunities lie?

Even with outflows threatening to wipe out 1/3 (or more) of the industry (according to various press reports), there are some hedge fund allocators working hard to identify where the next set of opportunities will arise. I remember that once, during a sailing competition, my coach said: “Once you touch the bottom, you can only do better…or start digging”. By the end of that competition, my yacht club was in last place.  As he had predicted, we simply couldn’t do any worse.  Later that year, however, our team clawed our way back to a silver medal at the national championship. Like that sailing team, it is likely that we shall all wake up in a brave new world full of opportunities.

As an example, distressed debt is one particular opportunity that I believe will be the next wave to ride..  Why?…

• Investment Grade (IG) and High Yield (HY) spreads went through the roof;
• All but one high yield sector is trading at distressed levels;
• Leveraged loans and mortgage pools underwent a dramatic transformation as a result of excessive liquidity conditions;
• Massive dislocations took place in IG and HY capital structures, cash and derivatives market.

If the default rates eventually met spreads in 2009, the supply of new distressed debt should subside somewhat relative to demand, which probably would be good news for distressed investors. Furthermore I expect an unprecedented supply of juicy fallen angels’ paper, which typically yields higher alpha and lower tail risk than any other distressed security.

There is little question that a gale force headwind blew the hedge fund sector off-course in 2008.  But as any sailor will tell you, headwind - like any wind - can power a boat forward as long as the sails are trimmed right.

- T. Sanzin, December 2008

(Editor’s addendum: Related news items: John Paulson looking to buy distressed debt: report [Reuters, Dec. 31], Yale’s Swensen Sees ‘Extraordinary’ Opportunity to Snap Up Debt [Bloomberg, Jan. 2] )

The opinions expressed in this guest posting are those of the author and not necessarily those of AllAboutAlpha.com.

It’s fair to say that the Madoff situation has added insult to injury for the hedge fund industry and may have prompted some hedge fund investors to finally capitulate.  The New York Post recently wrote:

“Now the worry is that hedge-fund clients will use the scandal as a final reason to pull money from even solid-performing managers. Although Madoff technically did not run a hedge fund, the structure of his $17 billion asset-management operation was similar to some hedge players.

“What’s more, Madoff’s ties with hedge fund of fund mangers, who placed their clients’ money in his advisory business without doing the kind of due diligence that might have uncovered the alleged scheme, has further eroded confidence.”

But wait…

But with many Madoff assets coming from private banks, there may be a schism developing within the ranks of institutional hedge fund investors.  Public pension plans may not be running for the hills, says the WSJ:

“Hedge funds have suffered through their worst year in more than a decade, punctuated by the Bernard Madoff scandal. But some public pension funds aren’t writing them off, at least not yet.

“Chief investment officers for pension funds note that despite some worrisome drawbacks, hedge funds continue to outperform stocks, and by a good margin. Hedge funds are down less than 18% this year, while the Standard & Poor’s 500 index has dropped close to 41%.”

Buy vs. Build

Pensions & Investments recently found that European pensions remain solidly focused on absolute return strategies despite the Madoff saga.  In fact, P&I reports that several European mega-pensions are actually launching their own internal hedge fund operations to overcome the types of transparency issues raised by the Madoff fiasco:

“Driven by inadequate transparency, performance problems and redemption issues among external hedge fund managers, pension fund officials at the 367 Danish kroner ($69 billion) ATP pension plan and the €23 billion ($32 billion) Ilmarinen Mutual Pension Insurance Co. - a multiemployer [FInnish] pension fund  - are quickly building their own hedge fund expertise.

“Also, Hermes Investment Management Ltd., London, which manages the £34 billion ($52 billion) BT Pension Fund, is also preparing to launch its own hedge fund team as soon as early next year. As a result, billions of dollars in absolute-return strategies from these three funds might be shifting in-house.”

These investors have opted to keep the baby (alpha-centric investment strategies) while throwing out what they see as the dirty bathwater (an opaque and illiquid hedge fund business model).

“Dislocations” too juicy to resist

Over the past couple of months, a growing chorus of hedge fund has been suggesting that recent market dislocations are good news for alpha-centric strategies in the medium and long-term.  And this may not just be empty marketing.  According to P&I, institutional investors are sensing the same opportunities.  Thomas Gunnarsson, the co-chief investment officer for alpha at Danish plan ATP tells the newspaper:

“There are tremendous dislocations in the industry, among them in the credit and convertible (bond) space. Going forward, there is going to be a lot of opportunities … We’re trying to develop in-house expertise to place us in a better position to take advantage of those opportunities.”

Pensions competing with traditional hedge funds?  Just another example of why it’s not about hedge funds, mutual funds, or pension funds, it’s all about alpha.

Hedge fund outflows vs. mutual fund outflows

In a related story, FT reported this week that November hedge fund asset outflows topped out at $32 billion according to Trimtabs.  When you add this to HFR’s Jan-Oct net redemption figure of $43 billion, you get $75 billion or about 3.75% of YE ‘07 AUM.

Also this week, the Investment Company Institute (ICI) reported mutual fund asset flows for November -  providing some interesting perspective on these numbers.  While assets in US mutual funds were down by $261 billion in November, only $41 billion of that was from net redemptions.  The rest was from negative returns.  For the year to November 30, investors pulled $197 billion out of US mutual funds or about 1.6% of YE ‘07 AUM.  For stock funds, Jan-Nov redemptions were about 3.3% of YE ‘07 AUM.

That’s not too far from the hedge fund figures above, suggesting that hedge fund redemptions - at least so far - are comparable to US stock mutual redemptions.  But before the hedge fund industry breathes a sigh of relief, it should check out Trimtabs’ December hedge fund redemption forecast (cited by the FT): $80 billion.

If the New York Post is right about the Madoff scandal providing a reason to pull money out of hedge funds, that number could be at the low end of the range.  After all, it appears that well over $20 billion could have been instantaneously sucked out of the industry on December 11.

As 2008 enters the history books, we look back at the top ten most popular posts at AllAboutAlpha.com over the last 12 months.  As you can guess, most have a decidedly negative tone - redemption gates, shrinking AUM, warnings over quant models, securities lending problems, terrible monthly performances…

Thankfully the year is just about over.  If you are in the office today, here is a walk down memory lane that will make you especially happy to welcome in a new year.  (We have temporarily granted free access to all of these archived posts.)

1. Securities lending starting to dry up a little?: The hedge fund industry relies on short-selling. Short-selling relies on securities lending. And securities lending relies on the willingness of institutional investors to temporarily part with their stocks. So what happens if those lenders get nervous?
2. Hedge funds discovered not to be an “asset class” after all: When is an asset class not really an asset class?
3. Stigma of redemption gates fading fast: Back in the old days (like, in August), shutting a “redemption gate” used to be a form of punishment. Now it’s more like “tough love”.
4. Exactly how much of the hedge fund industry is about to get chopped anyway?: Recent estimates about the imminent shrinkage of the hedge fund industry have varied widely. So we asked one expert to help us cut through the confusion.
5. Replicating Hedge Funds: Traditional beta or alternative beta?: In this guest post, Partners Group’s Lars Jaeger says that although you could have replicated hedge funds using equity beta over the past 4 years, “alternative beta” is still where it’s at.
6. Exactly how bad was September for hedge funds?: If hedge funds beat equity markets in September, then what’s all the fuss about? For a visual answer to that question, just take a look at these charts.
7. Shadwick to Quants: “Financial models should come with health warnings!”: In this guest post, Dr. William Shadwick, developer of the Omega Function used in risk management, warns that “over-modeling” has “negative consequences”.
8. Asness: Quant funds not actually “HAL 9000? black boxes: In an article by Alpha magazine, AQR’s Clifford Asness says that quant funds can still profit from new opportunities and that they are actually far more transparent than most fundamentally-driven funds (or than the “HAL 9000″, for that matter).
9. Alternative Viewpoints: Commodities not about “buy and hold”: There is little doubt that commodities are hot. But as Keith Black, CAIA, argues in this guest post, investors must move well beyond simple “buy and hold” strategies.
10. Morningstar’s Deutsch: 130/30 “not monolithic” but does represent a “convergence” in money management: In this guest post, Morningstar’s Steve Deutsch has a bird’s-eye view of the burgeoning 1X0/X0 field. Today, he shares this perspective, concluding that money managers are stealing a page from the telecom playbook.

End of the Hedge Fund? Unlikely, according to Washington Post columnist Sebastian Mallaby who writes, “Even if you define Madoff’s investment outfit as a hedge fund, which for various reasons is debatable, there’s nothing in this saga that supports clamping down on the industry.”

Hedge funds return to roots as alpha claim refuted: This prediction of the hedge fund apocalypse tops all others.  Robert McAdie, a credit strategist at Barclays Capital, was quoted by Reuters last week as saying “Eighty percent of the hedge fund sector will not be here in three to four months“.  Check back in April for an update…

Regular readers may recall this post on “hedge fund forum shopping” - the theory that hedge funds search out the least-regulated jurisdictions in which to ply their trade.  AIMA’s Canadian chapter announced last week that the study cited in this post was the recipient of the organization’s annual research award.  If you want to compare jurisdictions side-by-side, this study is the place to start.

Man bites dog!…GLG Partners to buy SocGen UK asset management arm: Here’s an addendum to our recent  post on hedge funds being snapped up by traditional asset managers.  Except this time, the hedge fund is the one doing the buying.

In another twist on the traditional, T. Boone Pickens has reportedly decided to unilaterally relax quarterly redemption and 90-day notice rules on his equity fund - begging the question, why did he have these liquidity rules in the first place?

University endowments may reduce their hedge fund exposure next year, but not for the reason you might think.  Quoting InvestHedge, Bloomberg reports that “Hedge funds might be put ‘on the backburner’ when endowments have to fulfill previous obligations to private-equity managers.”

And here’s another problem faced by otherwise healthy hedge funds…J.W. Henry worries that even strong hedge funds may go under.

Breaking Views reports on “six changes they [hedge funds] need to prepare for” (via IHT).  One is that industry concentration will accelerate.

But Portfolio.com’s Jesse Eisinger has a different view.  Writes Eisinger: “Most hedge fund watchers think the biggest fund managers will only get bigger. But that’s hard to see…”

At least hedge funds aren’t the only ones looking at a huge drop in fees next year.  Thomson reports that “UK unit trusts and open ended investment companies have seen rises in both TERs [total expense ratios] and annual management fees for equity funds for the past ten years.”

Before we take a brief break, we wanted to share a letter we recently received from an 8 year old financial savant last week.  Apparently 8 year olds have always asked the tough questions (see another famous example).

Dear AllAboutAlpha.com:

I am 8 years old and just lost my allowance in a giant Ponzi scheme. Some of my little friends say there is no hedge fund alpha. Papa says, “If you see it on AllAboutAlpha.com, it’s so.”

Please tell me the truth, is there hedge fund alpha?

- Virginia Jones

Virginia, your little friends are wrong. They have been affected by the skepticism of a skeptical age. They do not believe unless they calculate ex post. They think that nothing can be which is not comprehensible by their algorithms. All factor models, Virginia, whether they be men’s or children’s, are inherently bias. In this great investment universe of ours, any portfolio is a mere insect, an ant, in its exposure when compared with the boundless financial market around it (as measured by its breadth, truth, knowledge, and its information ratio).

Yes, Virginia, there is hedge fund alpha. It exists as certainly as fear and greed exist, and you know that they abound and give to your portfolio its best opportunity for upside volatility. Alas! How dreary would be the world if there were no alpha! It would be as dreary as if there were no Virginias. There would be no poetry, no romance, no arbitrage to make tolerable this existence. We would have no enjoyment, except in beta and risk-free returns. The external light with which active management fills the world would be extinguished.

Not believe in hedge fund alpha! You might as well not believe in a “ten-bagger”. You might get your papa to hire men to watch all the prime brokerage accounts on Christmas eve to measure alpha, but even if you did not see alpha that night, what would that prove? Nobody sees alpha in such a short time frame, but that is not a sign that there is no alpha. The most real things in the world are those that neither Riskmetrics nor Beauchamp nor Pertrac can see in such a short time period. Did you ever see non-economic players consistently losing by taking the other side of that copper trade? Of course not, but that’s no proof that they are not out there. Nobody can conceive or imagine all the wonders that are unseen and unseeable in the world.

You tear apart your Jaguar and see what makes the noise inside, but there is a veil covering the market which not the newest Bloomberg terminal, nor even the united strength of all the strongest global macro managers that ever lived could tear apart. Only inefficient markets, patience, several dozen Ph.D.’s, and an “edge” can push aside that curtain and view the asymmetrical beauty and glory beyond. Is it all real? Ah, Virginia, in all this world there is nothing else real and abiding.

No hedge fund alpha! Thank God it lives and lives forever! A thousand years from now, Virginia, nay, 10,000 years from now, it will continue to make glad the heart of investors.

- We’ll be back on Monday.  Happy Holidays.

Yesterday we told you about a 2006 study of the SEC’s “Form ADV”.  Academics questioned whether the form - a centerpiece of the SEC’s plan to regulate hedge funds that year - was “redundant” since the due diligence performed by many hedge fund investors reveals the same information anyway.

Today, we continue on the theme of hedge fund due diligence with a look at another study co-authored by two of the same authors.  In “Hedge Fund Due Diligence: A Source of Alpha in Hedge Fund Portfolio Strategy“, Stephen Brown, Thomas Fraser and Bing Liang examine the value of the due diligence performed by funds of funds.  This is a particularly relevant issue right now as funds of funds come under criticism for not being able to forecast the Madoff saga.

Brown, Fraser and Liang cite a previous study that most hedge fund liquidations involved an operational component and over half of hedge fund liquidations prior to 2003 were the result of “operational issues alone”.  In fact, that study (by Feffer & Kundro) found that:

• 41% of liquidations involved “misrepresentation of investments and performance”,
• 30% involved “misappropriation of funds and general fraud”,
• 14% involved “unauthorized trading and style breaches,and,
• 15% involved “inadequate resources” or “other operational failures”

Brown, Fraser and Liang estimate that the average fund of funds due diligence effort costs US$50,000 to US$100,000 per underlying fund.  Like any fund cost, it represents a net against alpha.  Expenses and management fees, after all, are uncorrelated to returns and therefore are pure (and negative) alpha.

Therefore, as fees fall, alpha rises.  Since due diligence costs are essentially fixed, the larger the fund of funds, the lower the fee per dollar of assets.  So more AUM in a fund of funds necessarily leads to greater alpha, ceteris paribus.

Great theory.  But does the empirical evidence support this hypothesis?  Yes, according to the authors:

“Alphas of large funds of funds are significantly higher than those of small funds of funds, evidence of significant economies of scale…”

“Funds of funds large enough to absorb the high cost of due diligence have in principal a significant competitive advantage over smaller funds of funds.”

By comparison, there appear to be dis-economies of scale for single-manager hedge funds.  The authors divided single-manager funds into AUM quintiles and compare their performance.  It turned out that the largest single-manager funds (quintile #5) actually had the lowest returns.

The study also made another interesting observation.  It found that larger funds were more likely to use more “well known” service providers (auditors, administrators, counsel etc.).  While this makes intuitive sense, the authors propose it as evidence that small funds (single-manager and FOFs) “lack the necessary funding to compete effectively with their larger brethren”.

Despite concentration in the accounting industry, the study found that only 26.8% of single-manager funds and 30.9% of funds of funds actually used “well known” auditors (i.e. those who were used by more than one other fund ).  Less than half of the largest funds of funds used well known auditors and only a third of the largest single manager funds used them.

So smaller funds of funds face a double-whammy.  They sacrifice alpha in the form of higher due diligence costs and they lack the marketing benefits of well known service providers.

Could regulation of the hedge fund industry have prevented the Madoff fiasco?  Perhaps.  But likely not the specific type of regulation envisioned in the SEC’s failed attempt to regulate hedge funds back in 2006.

Ironically, Madoff’s investment advisory business “voluntarily” registered with the SEC that year.  That was right around the Commission’s failed bid to have all hedge fund advisers register with it.  Many other hedge funds had already done so when Phil Goldstein’s suit against the SEC eventually vacated the ruling.  However, the surfeit of fund information that resulted from the registration drive provided academics with a unique chance to compare operational risk factors with more traditional investment risk factors.  Stephen Brown, William Goetzmann, Bing Liang, and Christopher Schwarz did just that in this paper called “Mandatory Disclosure and Operational Risk: Evidence from Hedge Fund Registration”.  (Brown was recently asked about the topic in this AP piece on Sunday)

The abandoned plan would have seen all hedge fund managers submit a form “ADV” to the SEC containing operational information (see Madoff’s Form ADV here).  According to the authors the form was designed as a “deterrence of fraud”:

“The Form ADVs for this larger sample contain a wealth of information, previously unavailable for many managers, about fund characteristics such as potential conflicts of interest and past legal and regulatory problems. Both of these relate directly to the stated purpose of the disclosure, which includes “deterrence of fraud,” “keeping unfit persons from using hedge funds to perpetrate fraud,” “adoption of compliance controls,” or more generally, the “avoidance of operational risk.”

Given the assumption that many hedge fund investors also conduct some of their own due diligence on hedge fund investments, the authors ask the following question:

“…are Form ADV filings simply redundant and expensive, or do they provide valuable, otherwise inaccessible information to participants in the market for hedge fund services, thereby helping them avoid investing in potentially fraudulent firms?”

Stamp of Approval

Last year we wondered if voluntary SEC registration for hedge funds could be misused as a “seal of approval” when marketing hedge funds.  The authors of this paper wondered the same thing a year earlier and hypothesized that voluntary registration could be framed as a “signal of quality”…

“…we find evidence that the information in the form has the potential to add value to the investor decision-making process. Hedge funds operated by managers filing Form ADV in 2006 had better past performance and had more assets than those operated by managers who did not file either because they were technically exempt from the filing requirement, or because they simply chose not to file. This result suggests that filing alone may be a potential signal of quality.”

Time’s Justin Fox recently expounded on the moral hazard created by the registration of Madoff’s funds and related brokerage:

“…regulation of such investment funds ‘communicates confidence in a product that is riskier than normal investors should get involved in,’ as then Treasury undersecretary Robert Steel put it at a conference on hedge fund regulation last year.”

“For some investors and fund-of-funds managers, the regulatory imprimatur that the SEC gave Madoff’s brokerage may have communicated confidence in the investment products he sold on the side.”

Potential Conflicts of Interest

According to Brown, Goetzmann, Liang and Schwarz, Form ADV was meant to reveal potential conflicts of interest…

“A number of variables relating to potential conflicts of interest are required by Form ADV. In particular, the form asks whether any employee or entity controlled by the firm is affiliated with another type of financial institution such as a broker-dealer, mutual fund, or limited partnership. It asks about participation in clients’ transactions, including proprietary interest in transactions, sales interest in transactions, brokerage discretion, and custody of client assets. In each of these cases, the potential exists for the manager to influence client decisions, or make decisions on the client’s behalf that benefit the manager at the expense of the client.”

In “Five Ways to Avoid a Ponzi Scheme: Madoff Edition“, U.S. News & World Report recommends that investors “dig deep” by looking at Form ADV.  Unfortunately, Madoff’s ADV clearly states that it is affiliates with a broker-dealer.  This was a well known fact among many investors who also performed their own due diligence and it did not on its own disqualify their allocation of capital to the fund.  Many of the investors who chose to invest in the fund were also aware of this fact.  The extent to which the Form ADV was, in fact, instrumental in revealing this information remains a big question mark.

“Problem Funds”

Brown et al divide the roughly 2000 hedge fund ADV forms studied into “non-problem” funds (funds answering “no” to at least one regulatory infraction Section 11) and “problem” funds (funds that answered “yes” at least once - no matter how minor).  Approximately 15% of hedge funds were tagged as “problem” funds - about the same percentage as the number of “problem” advisers overall (hedge and traditional).

Interestingly, the “problem” funds had a lower leverage, volatility and return than the “non-problem” funds.  As the chart from the paper below shows, problem funds were also slightly bigger and older, and had slightly lower incentive fees and lock-up periods.

Madoff would have been tagged as a “problem fund” by this methodology due to a minor 2005 NASD violation detailed on the ADV.  In keeping with other “problem” funds, Madoff was also relatively old and large, and had lower incentive fees (0%).

The study goes on to show that “problem funds” have much higher “external conflicting relationships” - 73% of problem funds are affiliated with a broker dealer, vs. only 24% of “non-problem” funds.  (This may not come as a huge surprise given the fact that increased business complexity leads to greater probability of operational infractions.)

To test whether Form ADV is actually redundant, the authors of this examine whether “problem” funds have trouble raising capital.  If “problem” funds had trouble raising capital, that might suggest that investors were generally already aware of the fund’s previous infractions or its potential conflicts of interest.

Surprisingly, it turns out that “problem” funds did not actually have trouble raising capital.  While this may suggest that investors must have been unaware of the information revealed by Form ADV, it could also just reflect the fact that a fund-raising handicap was off-set by the marketing benefits of being bigger, older, less leveraged, and less volatile.

Prophetically, on February 1, 2006, the day the (late) SEC hedge fund registration rule came into effect, CNNMoney.com noted:

“Opponents also question whether SEC registration will help protect investors against fraudulent managers, especially since some of the SEC’s hedge fund enforcement actions were levied at firms that were already registered with the SEC.”

In the end, Form ADV may indeed have contained information that was material to investors’ decisions on Madoff.  But it remains far from clear that Form ADV was, in fact, a critical source for that information or whether it was simply restating what was already known to investors.

In September, we suggested that the recently imposed bans on short-selling certain stocks would provide academics with a field day as they examined whether such restrictions actually had the intended effects.  We compared it to the situation immediately after 9/11 when climate researchers were afforded an opportunity to measure the effect of airplane contrails on ground surface temperatures in the United States.

Well the data is starting to roll in now.  And according to a study published by the Cass Business School in London, our contrail analogy may have been a little off the mark.  As Ian Marsh and Norman Niemer point out in “The Impact of Short Sales Restrictions“, it is virtually impossible to compare the performance of stocks during the ban with their previous performance histories.  Dramatic market volatility that was coincident with the bans meant that the usual caveat “all else being equal” simply didn’t apply.  This is like climatologists studying post-9/11 ground surface temperatures in the presence of a coincidental surge in sun-spot activity.

So instead of just comparing the statistical properties of pre-ban returns with those from the ban period, Marsh and Niemer also compare the statistical properties of the “restricted” stocks with those of the “unrestricted” stocks (summarized by us below as “A” and “B” respectively).

In other words, it’s like they’re comparing the ground temperature in the US before and after the absence of airplane contrails and the ground temperature both in the US and Canada.

Possible Findings

Everyone seems to have an opinion on the true effects of short-selling on security prices.  In part, this results from several different and apparently disparate academic studies over the years.  Marsh and Niemer point out that a 1977 study confirmed the prevailing intuition that short-selling pushed prices down.  On the other hand, they say, a 2006 study found that short-selling actually put upward pressure on prices since buyers were comfortable that all negative information was already baked into them.  Several other studies have been inconclusive with regard to prices but have found that volatility and market efficiency rise in the presence of short-selling.

Actual Findings

Unlike ground surface temperatures, the authors find that return behaviour actually changed very little in the absence of otherwise ubiquitous forces (shorting).  As they put it:

“We find no strong evidence that the imposition of restrictions on short selling in the UK or elsewhere changed the behaviour of stock returns. Stocks subject to the restrictions behave very similarly both to how they behaved before the imposition of restrictions and to how stocks not subject to the restrictions behave.”

But Wait…

While this seems to put a rest to the assumption that shorting (or the lack of it) has a dramatic effect on price behaviour, there is another important dimension to the debate - market efficiency.  Unfortunately for advocates of the shorting-as-market-efficiency-creator argument, Marsh and Niemer actually find that the removal of shorting did not increase serial autocorrelation in returns (a common measure of the randomness of the proverbial “random walk”).  In other words, markets were no less efficient without shorting.

In the end, the authors concede that any unique behaviour displayed by short-restricted stocks may have just resulted from sector-specific influences rather than the short-bans themselves.  To return to our surface temperature analogy, it’s like a comparison of US and Canadian ground surface temperatures both in the absence of airplane contrails - but with a nasty cold front moving through the US midwest at the same time.

The relatively small size of the short-ban window (31 trading days in this particular study) means that any chill in prices could conceivably be the result of just such a freak mid-western cold snap.  To mitigate for this possibility, Marsh and Niemer perform a bunch of other statistical tests.  However, none of these change their basic conclusion that the universe seems to want to unfold as it wishes - with or without short-restrictions.

When November hedge fund returns began to trickle in early last week, they appeared to be in line with historical results in relation to equities.  That’s not say that the numbers were stellar.  But many strategies’ returns fell on or close to their long-term linear regression line (vs. the S&P).  Then came the Madoff fiasco.

Over the weekend, Credit Suisse adjusted their initial estimate for the “Equity Market Neutral” category from basically flat to minus 40% to reflect the fact that three of that sub-index’s constituents have apparently logged -100% returns (Kingate, Fairfield Sentry, and Rye Select according to Marketwatch).  While this adjustment does not seem unwarranted, it does raise some important questions:

• The funds are assumed to have a November return of -100%.  But what about previous months?  While Bernie Madoff seems to have let the cat out of bag last week, the funds would have had a questionable value in all previous months as well.  Assigning the entire loss to November may be the only prudent action without further information, but the drawdown could also arguably have been placed in December’s results, not November’s.
• Are asset-weighted hedge fund indexes too concentrated?  While the occurrence of anomalies in any data set can serve the useful role of “baking in” the probability of outliers, the Madoff affair will be forever immortalized in a strategy track record that has a massive 40% drop-off right in the middle of it.  This will make it difficult for academics and practitioners to analyze the investment potential of the strategy without polluting their analysis with important, but exogenous, variables such as operational risk and regulatory oversight.
• Adding a -40% return to the data set for an equity market neutral index makes skew and kurtosis virtually useless.  For example, when you change last month’s flat return to a -40% return in the HFRI returns, for example, the result is an increase in excess kurtosis from 1.5 to 181.00 and an increase in the skew from 0 to around -12.0.  So we ask a question familiar to Canadian and Finnish investors whose equity indexes were overwhelmed with mega-caps Nortel and Nokai in 1999: Is an alternate “Market Neutral ex-Madoff Feeders” index now required?

While Madoff himself says that all the money is gone, we’re more than a little curious about the actual performance of his alleged investment strategies (whatever they actually were).  In other words, what was the actual return of the split strike conversion strategy?

In any case, we added November’s HFRI returns to the scatter plots we showed you back in October.  As you can see from the charts below most strategies returned approximately what you might guess using a simple linear regression of monthly returns since January 1990 (shown by the black lines in the charts below).

We start with equity market neutral since this prototypical hedge fund strategy had been holding-up very well over the past year.  (Note: The HFRI is a “fund weighted” index of 2,000 constituents.  So even when the Madoff feeder fund returns are updated (if they haven’t been already), the index won’t change that much.)

Like the Equity Market Neutral sub-index, the HFRI Composite Index was also in line with long-term results in both October and November.

However, the HFRI Relative Value Index continued to under perform long-term results.

Similarly, the HFRI Event Driven Index underwhelmed in all three months…

But the HFRI Global Macro Index continued to shine - out performing a linear regression in all months…

Many will say that simply losing less than the market flies in the face of the hedge fund “promise” of absolute returns.  But as author Alexander Ineichen has argued, such asymmetric returns are the real promise of alternative investments.

The European Central Bank published it’s semi-annual “Financial Stability Review” last week and as usual, it contains some interesting observations about the hedge fund industry.

Cautious attitudes of hedge funds “detrimental to the functioning of financial markets”

Some hedge fund critics point to hedge fund “deleveraging” and hedge fund “selling” as enablers, if not the cause, of the recent market downturn.  Although selling off a market neutral portfolio has a net zero impact on markets, many hedge funds are long-bias and therefore it could still be argued that they put downward pressure on prices.  But the corollary of the hedge fund induced market crash is that hedge funds must have also been the ones supporting the market in the good time.  The December ECB report notes that hedge fund redemptions are therefore bad for markets:

“The reduced availability of leverage notwithstanding, such cautious attitudes of hedge fund managers, even if probably justified at a fund level, are detrimental to the functioning of financial markets, since they imply asset sales and deprive markets of their most active participants.”

Reduced hedge fund leverage

Whether it was self-induced or was thrust upon it, there seems to me little question that overall hedge fund leverage has been falling for quite come time.  The two charts below from the CB report show how gross exposure (of long/short funds) and overall leverage (of all funds) have both fallen over the past 18 months.  (click to enlarge)

Not the first time that really terrible performance has plagued the laggards

The report points out that while there have been plenty of hedge fund disasters (e.g. 50% drawdowns), the proportion of funds with returns in that range is about the same as the proportion in that range in 1999.  In fact, the worst 10% of funds this year has only performed a little poorer than the worst 10% of funds during the entire 1999-2003 period (left chart - click to enlarge).  The difference this time is that the mean fund (solid blue line) is way down below its 1999 lows.

Using a lack of reporting as an indicator of attrition, the ECB makes a startling observation in the right hand chart above.  While launches are way off, actually “liquidations” are actually below their long term average rates.  However, the proportion of funds experiencing some other form of “attrition” is way way up.  As a result, the 12 month moving sum of net new funds dipped into negative territory in mid-2007.  Since a disproportionate amount of hedge funds are below average size, we expect the red line to stay below zero for a year or two.

In the end, the ECB seems to concur with the Economist, which wrote in an October article that the challenge facing hedge funds isn’t deleveraging, but redemptions.

“…in the period ahead, the main challenges faced by most hedge funds will be investment performance results and the retention of dissatisfied investors. Since leverage levels did not appear to be high, the likelihood of further deleveraging is rather low. However, further sizeable position unwindings by hedge  funds due to probable higher investor redemptions and more frequent cases of hedge fund liquidation may pose a challenge to financial markets.”

Academic research on hedge funds can be tremendously valuable to investors. But with increasing complexity, comes a greater chance that research conclusions can be interpreted in many different unintended ways.  For example, a widely publicized study released last week by Andrew Ang and Nicolas Bollen was presented by some as evidence that gating provisions themselves have a certain calculable cost.

As Reuters reported:

“In a paper titled “Locked Up by a Lockup: Valuing Liquidity as a Real Option,” Mr. Bollen and Columbia Business School’s Andrew Ang show that a manager’s right to block redemption requests “generates an implied cost of between 5% and 15% of the initial investment.”

This claim was likely based on the following statement in the introduction to the paper:

“…we show that a manager’s discretion to block redemption requests using gate restrictions or suspension clauses generates an implied cost of between 5% and 15% of the initial investment.”

Gate Provisions vs Gate Closures

Like Reuters, we read this to mean that the manager’s right (option) to cease redemptions was worth the equivalent of 5-15% of the value of the fund.  But a more detailed reading of the paper left us with the understanding that the manager’s actual decision to halt redemptions - not simply their option to do so - had the effect of immediately decreasing the value of the fund by 5-15%.

Ang and Bollen put a price on the investor’s option to redeem at their freedom.  The following table shows the value of a fund with a given volatility, a given likelihood of failure, and various expected mean returns (6%-14% per annum) under 5 separate liquidity regimes (columns from left to right: no liquidity, 2 yr lock-up + 3 month notice,  2 yr lock-up only, 3 month notice only, no restrictions at all).  The numbers represent the fair value (in dollars) for a fund with a $100 NAV on the day of its launch (i.e. at “Age=0″).

As the authors explain:

“Panel A shows that for relatively low expected returns, such as 8%, the potential cost of redemption suspension can be enormous, with $85.37 [for the no-liquidity scenario] $100.26 [for the 2 yr lock-up, + 3 month notice scenario]. This implies that the investor is receiving an asset worth about 15% less than NAV [when gates are closed], rather than one worth about par when the liquidity option is honored.”   [our notation]

So it would appear that a newly-gated (or always-been-gated) fund should suffer a 15% decrease in expected value vs. a fully-liquid one.  But this does not necessarily mean that a fund with a mere gating provision should be discounted by this amount.

We called Bollen to confirm this and he explained that in situations where investor redemptions coincide 100% with the imposition of gates, then an initial investment in a fully-liquid fund is, for all intensta nd purposes, locked-up.  In other words, liquidity is only there when you don’t need it - and disappears when you do need it.

Of course, hedge fund investors redeem for all types of idiosyncratic reasons.  So the value of the possibility of a gate being imposed falls somewhere between the extremes of a 100% liquid fund and 100% illiquid fund.

Recovery Rate

Still, an instant drop in expected value of a fund once a gate has been closed is still a tough nut for investors to swallow.  This immediate discount is based on a number of assumptions regarding the fund’s volatility, mean return, the likelihood of the fund liquidating given its strategy and age, and the expected recovery rate in the event of such a liquidation.

As Ang & Bollen explain, their analysis assumes that if a gated fund liquidates, investors will receive only 50% of their money back:

“Upon failure, we assume as a base case that investors receive a payoff of 50% of the prevailing NAV of the fund, reflecting additional loss of asset value during liquidation. The 50% liquidation cost is based on results reported in Ramadorai (2008), who analyzes a sample of transactions on a secondary market for hedge fund investments conducted on Hedgebay.  During 66 “disaster” transactions, involving fraud or collapse, the average discount of transaction price to NAV is 49.6%.”

Dead Funds

But the final discount to NAV is only a proxy for the actual recovery rate for a liquidated hedge fund.  Regular readers may remember Ramadorai’s paper from this AllAboutAlpha.com post.  In his paper, Tarun Ramadorai of the University of Oxford finds that investors trying to redeem out of funds that eventually end in “disaster” do so at a 49.63% discount to last reported NAV (note: “disaster funds” are define as “funds that suffered heavy and publicly reported losses and are either liquidated, or likely candidates for liquidation, or have been implicated in the press for fraud.”)

But other researchers say that the actual amount recovered when funds liquidate may actually be far higher than 50% (i.e. the loss may be much lower).

In a paper published around the same time as Ang & Bollen’s, James Hodder, Jens Carsten Jackwerth, and Olga Kolokolova studied “dead” hedge funds (defined as those who stopped reporting to a database).  Hodder, Jackwerth and Kolokolova argue that common assumptions about “dead” funds may be overstated:

“…we find that the estimated average delisting return is fairly small and nowhere near values of -50%… [our research] provides rather strong evidence that on average, delisting returns are far from disaster scenarios with exit returns of -50% or worse.”

In fairness, Ramadorai’s 50% recovery rate is based on funds that suffered “heavy losses” prior to liquidation and Hodder, Jackwerth & Kolokolova base their findings on all funds that simply ceased reporting to a database.

But as Ang & Bollen show, the recovery rate still has a significant impact on the value of the investor’s option to liquidate at their freedom.  The following chart from the paper shows that the investor’s liquidity option on a fund with an 8% expected return has a significant value when recovery rate (”l“) is 50%, but no value at all when the recovery rate is, say, 81%.

So, the cost of the “no liquidity” (already-gated) regime in influenced by recovery rate assumptions.  But the recovery rate also impacts the cost of the plain vanilla “2 yr lock-up + 3 month notice” liquidity regime.   In the chart below from the paper, “restriction cost” refers to the cost of these standard liquidity restrictions (vs. the full liquidity regime).

Note that even if you assume a low 6% annual return and a 50% recovery rate in a potential liquidation, the value of the standard (2 yr lock-up + 3 month notice) liquidity restrictions is still less than 5% of the fund value.

This is a very interesting paper.  But as usual, we need to be careful when interpreting it.  The study is about the value of being able to redeem - not about the value of a manager’s option to cease redemptions.

Perhaps in an acknowledgment of the complexity of these issues, the authors draw only general lessons in their interview with Reuters:

“This paper was written for academics, but I think it has practical applications…The legalese that described the vague rights that managers have and that a lot of people may have skimmed over in the past could turn out to be very important.”

“Very important”, yes.  But contrary to media reports, the study does not actually value “the manager’s right to block redemption requests.”

Apparently retailers aren’t the only ones discounting their merchandise to bring wary shoppers into their stores this Holiday season.  Asset management firms are now priced to move.  Since their top lines are levered to the absolute value of capital markets, asset managers have seen a precipitous drop in their valuations recently.  In fact, the following chart from Pensions & Investments shows how valuations have fallen further than the overall stock market and even further than their own 2009 EPS estimates.

Retailers are proving this season, such deep discounting is bound to drive up volumes.  As Pensions & Investments noted:

“While the big drop in shares of money managers has not led to a burst of industry mergers and acquisitions, insiders do expect to see more consolidation, starting with midsize firms with mediocre performance.”

Consolidation

This “consolidation” has been gathering steam.  Reuters reported last week that $9 billion hedge fund manager PAAMCO picked up a stocking-stuffer in the form of Asian markets specialist $700 million KBC Alpha Asset Management.

It seems that shoppers are particularly interested in merchandise that is slightly damaged, but can be easily fixed (think Ikea’s “As Is” section).  Venerable hedge fund GLG Partners attracted immediate interest last month when it reported a few scratches and imperfections.  Reported Thomson Investment News:

“Hedge fund firm GLG Partners said on Monday that it had been approached by a number of sovereign wealth funds or families interested in making an investment, as it reported lower net income and assets.”

Man Group CEO Peter Clarke told Reuters last month that he’s going to wait until after Christmas Day to see what kind of deals he can score.  Said Clarke:

“Consolidation is undoubtedly going to happen … Longer-term we’d expect to be a consolidator in these markets…”

Even relatively puny hedge fund players are looking for something to put under the tree this year.  Hedge Funds Review reports that $600 million SilverStreet Capital sees opportunity for acquisitions.  Its CEO tells the magazine that micro-funds will have to read the writing on the wall:

“When the hedge fund market was growing, they could realistically expect to grow to anywhere between $500 million and $1 billion in assets within a few years. However, in an environment where hedge funds assets are not expected to grow, and may even shrink, these companies will have to re-asses their future. There is a lot of potential for acquisitions.”

Convergence

Last spring Richard Heller with New York law firm Thomson Hine told HFM Week what he thought would eventually drive acquisitions:

“There is also a convergence between private equity and hedge funds competing for the same investments. As a consequence, it’s actually easier in a sense to buy an entire fund than to go after piecemeal investments in which some of these funds already have positions.”

We’re seeing examples of this convergence right now.  For example, traditional long-only managers are also shopping for alternative managers.  The CEO of UK-based money manager Aberdeen told Thomson recently that he’s checking out the bargains:

“Funds of hedge funds (FOHFs) and funds of private equity are a lot cheaper than they were six months ago, and they are significantly cheaper than they were two years ago…FOHFs, for example, were selling for 15 percent of assets under management two years ago. They are now down to very, very manageable levels, very attractive levels, and a lot of them are subscale, so I think there is an opportunity to consolidate in that area…”

But read the return policy

Alas.  Sometimes the perfect gift just doesn’t seem to work out.  As Wealth Bulletin reports, some lightly worn acquisitions can still be returned for a refund or in-store credit:

“The acquisition of the fund of hedge funds IAM by Dutch bank ABN Amro in 2006 was reversed this year by its management buyout from Dutch-Belgo bank Fortis, which had bought ABN Amro’s asset management arm holding IAM.”