Among the television ads that book-ended this year’s U.S. Super Bowl extravaganza, Audi’s Green Car commercial truly stood out, not for the beautiful car or the amazing scenery but for its apt, modern-day take on the no-littering, no-polluting, no composting, no carbon-foot printing world we all now try, as much as we can, to live in.

Some iconic snapshots: A man pulled out of his home by a squad team for not composting a rind; another man arrested for choosing plastic over paper; a cop pulling over two other cops for using Styrofoam cups; and last but not least, an Audi A3 clean diesel driver allowed to pass an “eco” road blockade for not fouling up the air with noxious fumes – all to the tune of a song entitled “The Green Police.”

It was a deprecating take on what in the developed world at least has become a fairly all-encompassing issue: collective guilt over trying to follow – and keep up with – the ever-changing rules of keeping “green.”

The investing world has certainly been no different. In fact, in many cases, the “going green” mantra has become a mandate among pensions, endowments and other institutional investors, whose constituents are mandating money be allocated to clean-technology investments – through specific types of firms, fund managers or both.

Trouble is, and continues to be, that finding such investments and managers is easier said than done. A recent paper (click at the top of the page to download the complete version) published by Janelle Knox-Hayes with Oxford University’s Centre for the Environment, focuses on carbon emissions markets emerging as governance mechanisms to reduce greenhouse gas emissions and mitigate climate change – not only at the hands of regulators but also at the hands of private organizations.

In essence, the paper analyzes how organizations develop the three pillars of the carbon market institution: regulative, normative and cultural-cognitive constructs. Since organizations build the institutional pillars of the carbon market network, the strength of the institution cannot be determined by regulation alone.

The paper also draws on inherent issues prevalent in these emerging carbon credit markets: namely the debate over whether a “credit” is a physical piece of property, and if so how it is valued, traded and eventually cashed in.

The premise of carbon trading is fairly simple: polluters – companies, governments and people – purchase credits in various markets to offset the environmental damage they inflict, and “clean” firms and people sell excess credits they stockpile for being good environmental citizens.

An on-the-ground example might be an electric utility firm, where users pay a few cents extra for every kilowatt of power they use, which then goes to paying for stuff that reduces future CO2 emissions like a new gas-fired power station, which wouldn’t have been economically viable if not for the extra capital, and for the carbon credits it will also generate that can be sold.

It is a market that in theory at least is growing by leaps and bounds. A report published last year by PricewaterhouseCoopers entitled, “Capitalizing on a Climate of Change” noted the market has surged in the past five years, jumping to more than $120 billion from just $1 billion in 2004.

Still, the reality, according to Knox-Hayes and others, is that trading carbon credits in the context of a traditional marketplace is far more complex: carbon markets themselves aren’t necessarily designed to govern behaviors which emit greenhouse gas emissions.

Further, from a trading perspective, carbon credits provide the right to emit, but the credits themselves do not become a property right until they are traded, either over the counter (matching buyer to seller) through contract, or through an exchange in partnership with a registry.

In most cases, the property right, what many lawyers refer to as ownership title, is established using legal certificates that house carbon reductions that can then be traded or sold through Emissions Reduction Purchase Agreements (ERPAs), but these can take months to negotiate and settle.

The International Emissions Trading Association (IETA) has developed a Master Agreement to trade EU allowances, which can be traded more quickly, though some exchanges still require traders to provide a statement of sole claim to ownership. For instance, for offsets that were produced through a chain of companies, each company must sign a letter that they do not claim the right of the emission reduction.

All of which is to say that, despite the ever-growing recognition of going “green”, and despite the growing interest and mandates that investors, particularly on the institutional side, are facing, carbon trading as a viable way to both invest money and help the environment is still at a nascent stage – even with estimates showing the growth potential as huge (see chart below).

Indeed, as Knox-Hayes points out, while countries and regulatory bodies can and certainly have built carbon-trading markets, it is still up to private firms and players that participate in these markets to ensure they function – kind of like having the traders, computers and telephones at the Chicago Board Options Exchange.

Perhaps Audi’s ad for next year’s Super Bowl will be a spoof on a COE pit-trader trying to sell enough carbon credits to buy a car.

As this Reuters piece reminded everyone recently, hedge funds are “battling to offer more flexible fee structures.”

But as we recently learned, it’s not just hedge fund managers that are battling to be more flexible.  It’s also traditional managers who see flexibility as a critical tool in their battle against the hedge fund newcomers that are now battling for business from large institutional investors.

On January 22, 2010, the investment board of the Pennsylvania Public School Employees’ Retirement System (PSERS) voted to accept staff proposals to invest in two hedge funds, one from Brevan Howard and one from Oppenheimer Capital (final terms and conditions of both are still pending).

The Brevan Howard fund is described in internal PSERS correspondence as a “global macro/relative value absolute return fund.”  According to this correspondence, the fund has a 1.5% management fee and a 20% performance fee (paid semi-annually).  It also has an “operational services charge” of 0.5% and a redemption fee of “10% payable on redemption made within three years of acquisition.”

The Oppenheimer Capital fund is described in similar internal correspondence as being part of its proprietary “structured alpha strategy” that invests in the options markets.  The firm seems to have positioned its offering as an “innovative alternative strategy offered by traditional managers” (at least, according to PSERS internal correspondence).

Notably, the Oppenheimer fund has a zero percent (0%) management fee and sliding-scale performance fee that, according to internal correspondence, look like this:

• 27% of excess performance on first $100 million
• 24% of excess performance on second $100 million
• 21% of excess performance on assets in excess of $200 million

It also has a hurdle of 90-day T-bills and, like the Brevan Howard Fund, has a high water mark provision.

Culture Clash

Although both fund aims to deliver alpha, the terms surrounding these funds could not be more different.  In a way, they illustrate the choices facing institutional investors as they navigate the “convergence” between traditional and alternative investing.

The Brevan Howard Fund apparently has a 2% fee with a 20% performance fee paid semi-annually (historical returns contained in internal PSERS correspondence seems to suggest that the usual performance fee is actually 25%).  By contrast, the Oppenheimer fund has a 0% management fee and a slightly higher performance fee.

If the Oppenheimer fund had a weighted average performance fee of 25%, the additional 5% (over BH’s 20%) would equate to an additional  2% for the manager if the fund posted a return that was 40% higher.  In other words, you would be ambivalent between a guaranteed 2% or an additional 5% of profits if you believed you could generate an additional 40% returns – a tall order indeed.  (Compounding this fee drag is the fact that, according to PSERS’s internal correspondence, the Brevan Howard fund has a hurdle rate of 0%, while the Oppenheimer fund has a hurdle of 90 day T-Bills.)

PSERS internal correspondence described Brevan Howard’s “transparency” as “partial” and Oppenheimer’s as “full.”  We have no idea exactly what is meant by those terms.  But it would appear as though PSERS believes the traditional manager provides more information.  This could simply be a result of the different securities in each fund – or it could be representative of the typical modus operandi of each genus of investment manager.

In the tradition of many great hedge funds, the Brevan Howard fund has an initial lock-up period of 3 years (with an escape clause – albeit an expensive one) and quarterly redemptions.  By contrast, the Oppenheimer Fund is described as having no lock-up period and daily liquidity.

The Rub

By now, you might be wondering why anyone in their right mind would pay “2 and 20″ with a 3 year lock-up and semi-annual performance fees over a “0 and 25″ fund with no lock-up and daily liquidity.

The answer may lie in the historical performance of these two funds.  Both have produced impressive returns.  But the Brevan Howard fund has a Sharpe ratio of 1.6 – twice as high as the Oppenheimer fund’s still-respectable 0.82.  (Both funds protected clients’ capital relatively well in 2008, but Brevan Howard’s apparently posted a +20.45% return after fees).

Note that this is based on net (after fee returns).  So whatever extra fees Brevan Howard seems to charge should really be moot if the investor is still receiving a higher return.  This is a tough nut to swallow for those who find hedge fund compensation to be distasteful, unethical or unfair.  But if you have a fiduciary obligation to pension plan members, then it’s one that might need to be eaten.

In any event, not all hedge funds produce 1.6 Sharpe ratios and not all traditional managers are willing to take a flier on their own success with a 0% management fee.  So both managers seem to have played to their strengths. But their contrasting terms and conditions are emblematic of a growing clash of cultures as hedge funds and traditional managers engage in skirmishes along the “convergence” front lines.

Investment consultants are paid by institutional investors to anticipate what the future might bring – what asset allocations are safest, which managers are more likely to deliver alpha, and what liabilities a pension plan will face in the future.

But consultants seem to be absolutely inept at one thing: predicting the growth of their own businesses. In the latest installment of their “Annual Consultant Search Forecast,” management consultancy Casey Quirk and data vendor eVestment Alliance report that investment consultants underestimated 2009’s search volumes by a whopping 115% (on the basis of assets). Respondents to last year’s survey (conducted in last 2008) predicted a slight recovery in 2009 after a decidedly dismal 2008. But check out what actually transpired (chart created with data from 2009 edition available here and 2010 available edition here).

Coincidentally, respondents to this survey anticipated a growth of around 15% this year – nearly the same growth rate predicted at the outset of 2009.

Regular readers may remember Casey Quirk’s “Product Opportunity Map” from previous AllAboutAlpha.com coverage of this annual survey.  The April 2007 edition trumpeted hedge funds as “highest opportunity” with growing interest and a high “search focus.” (See 2007 post.)

Hedge funds remained the cat’s meow in the March 2008 edition, as Casey Quirk observed that:

“Seventy percent of the consultants surveyed expect to conduct the most searches in the hedge fund area, with nearly half of these consultants expecting to focus solely on hedge funds.”

Then came 2009, when the floor fell out of hedge fund demand and many investors put hedge fund callers on hold while they took calls from traditional managers (see 2009 post).  After being ranked #1 in expected search activity in 2008, hedge funds fell to #4, behind global equities, domestic (US) equities and fixed income.

(The most recent version of the Product Opportunity Map drops the reference to “search focus” and relies solely on expected growth in search interest.)

I get knocked down…

What a difference a year makes.   As one-hit wonder Chumbawamba once said “I get knocked down, but I get up again!” (Note to self: Find out if Chumbawamba ever got up again.)  Casey Quirk and eVestment Alliance now finds that hedge funds have clawed their way back to #2 in terms of expected search activity.

“Respondents predict resuscitating interest in hedge funds. More pension funds of all sizes realize non-correlated alpha will represent one of the few methods through which they can shore up funding gaps that collapsing equity markets re-opened in 2008-2009.”

Domestic equity is now the basement at #6 and check out the alternative investment newcomers:  “Emerging Market Equity” at #3 and “Commodities” at #5.

20/10 Vision

You know when you go to the optometrist and he asks you to compare endless pairs of possible lens prescriptions?  Well that’s what Casey Quirk and eVestment Alliance did this year.  The result is the following chart (click to enlarge):

Unfortunately, 2010 is the first year the firms have produced this data.  So we have nothing to compare it to.  Still, long (short) extension and quantitative strategies seemed to have totally struck out with investment consultants this year – making it a tough slog for our friends in the quant marketing field (you know who you are).  The report blames this on the lack of “…string three year performance numbers from these categories.”

Funds of private equity funds and funds of hedge funds are reported to be “rising in favor as mid-sized pensions, too small to make impactful direct investments boost their non-traditional allocations.”

Finally, the report says that “interest in absolute return strategies has surged as institutional investors become more outcome oriented in their investment policies and asset allocations.”

Rockin‘ down the highway / The highway patrol got his eyes on me / I know what he’s thinkin’ and it ain’t good / I’m movin’ so fast he can barely see me...

So go the famous lyrics from the Doobie Brothers’ iconic 1972 song about tearing down the road at full throttle.

Slightly different but along the same lines is the apt title for Jefferies & Company Inc.’s February analysis on merger and acquisition (M&A) activity in the asset management, broker-dealer and financial technology industries, On the Road Again. More…

Third-party marketers – a select group who have long made their living sourcing alternatives managers and strategies and then recommending those managers and strategies to potential investors – certainly haven’t had the best of times of late.

Despite being among the most diligent in terms of due diligence, manager selection and representation, it’s been a tough sell convincing institutions, high-net-worth individuals, family offices and the like that hedge funds are still the way to go. More…

American university endowments have long been held up as models of a new form of investing.  The so-called “Yale model” is standard fare at industry conferences and the recent travails faced by Harvard’s endowment have scratched a Schadenfreude itch felt by many commentators.  Way back in January 2007, The Economist raised the possibility that these beacons of alternative investing may someday have to pay the piper (see related post)…

“Simply putting 20% into hedge funds is no longer enough. The big test of their prowess will come when lax credit conditions tighten. John Griswold of Commonfund thinks that some investment committees, stuffed with alumni, may be starting to lose track of the risks their endowments are taking.”

Investment committees may indeed have been aware of the risks they were taking with alternative investments.  As a result, they under-weighted the traditional risks of long-only equity (known by previous, more cautious generations as “playing the market”) and instead invested in alternative strategies. More…

According to a June 2009 research note on “How Institutional Investors Think About Real Estate” by the Harvard Business School, institutions invest in real estate,”…because of its returns, the high cash flow component of its returns, the dampening of the volatility in a portfolio and as an inflation hedge.”  The note concludes that real estate is, “…an increasingly important component in the portfolios of institutional investors.”

Despite the bath taken by some real estate investors in 2009, a recent survey of institutional investors seems to corroborate this conclusion.  bFinance, the UK-based consultancy surveyed European and North American institutions in December 2009 to see how their views had changed since May of that year.

The firm asked investors if their target asset allocation had changed since May 2009.  It then measured the difference between the “increased” and “decreased” responses (sort of like the political pollster’s ubiquitous “favorable/unfavorable” rating).  Guess who’s the popular kid this year? More…

McKinsey & Company, the venerable consultancy, has a thing with geese.  In 2003, the firm published a report on the then-recovering asset management industry called “Will the goose keep laying golden eggs? (October 2003)“  Then, last month, it produced another report on the beaten-up asset management sector asking the same question “Will the goose keep laying golden eggs? (October 2009).”

Who is this mythical goose and what has bestowed it with powers of prognostication not seen since Punxsutawney Phil cornered the market on predicting the onset of spring? More…

Dust in the wind, sand through time, defunct Dubai, Dubailand gone bust: the anecdotes and analogies are endless (and beautifully illustrated in these poignant photographs taken by Lauren Greenfield as the real estate market was crumbling.)

Poor headlines aside, what has occurred once again in emerging markets, or at least in one Emirate in the emerging world, has set off what many worry could be yet another chain of unfortunate debt-defaulting events affecting banks, financial markets and everything in between. Does anyone remember Russia, Ukraine, Pakistan, Ecuador, Argentina, Moldova, and Uruguay, or going back even farther, Turkey? More…

Since well before the days of Gordon Gekko, regulators and policymakers have pondered whether vulture capitalists add value or simply destroy what little hope is left for ailing companies.

In general, research seems to suggest that private equity firms (of both the vulture and non-vulture persuasion) add significant social value (see AllAboutAlpha.com coverage) by reducing, not increasing the rate of bankruptcy of target companies.  Other studies have found that activist hedge funds are also associated with more successful outcomes – but mainly because they know how to pick the winning situations before diving in (see AllAboutAlpha.com coverage).  And further research suggests that activist hedge funds serve an important role in keeping management honest – a role some say should be played more aggressively by institutional investors (see AllAboutAlpha.com coverage).

A study released last month adds to the evidence that activist hedge funds add long-term value.  In an unfortunately titled paper (given recent blow-ups) called “Hedge Funds in Chapter 11″, Wei Jiang of Columbia, Kai Li of the University of British Columbia and Wei Wang of Canada’s prestigious Queen’s University (disclosure: am an alumnus) argue that the involvement of activist hedge funds in distressed situations is a predictor of better outcomes.

How much better?  When the trio compared the returns of Chapter 11 cases where hedge funds as major creditors with returns from Chapter 11 cases where hedge funds were absent, they found that hedge fund involvement was good news… More…

By: Konstantin Danilov, AllAboutAlpha.com Editorial Board.

In his recently released paper, Paul Kedrosky of the Kauffman Foundation discusses current state of the U.S. venture capital industry and ponders whether its burgeoning size is limiting investors’ returns from the asset class. LPs have continued to allocate increasing amounts of capital to VC funds, despite the precipitous decline in performance over the past five years: the 10 year returns for the industry, as calculated for the author, are barely ahead of the Russell 2000 Index, and will turn negative in 2010 as dotcom bubble returns are excluded. The lackluster performance is a fairly recent phenomenon – the string of low to negative returns began in 2004 – which Kedrosky attributes to three potential causes.

Maturing Sectors

First, the “bread and butter” sectors for VC, IT and Telecom, have vastly matured over the past two decades. While open source technology and vastly lower networking costs have decreased the barriers to entry for IT startups, venture investments in the sector have yet to show a commensurate decline. In 2008, tech-related investing still accounted for more than half of VC investment on a dollar amount basis.

No Cash-Flows, No Thanks

Some point to the decline in IPOs in a post-Sarbanes-Oxley world as the main culprit behind the recent performance woes. While, in the past five years the annual number of VC-backed IPOs has declined to almost half of the late 90s average, it is still in line with pre-dot-com levels. Kedrosky argues that, relative to the late 90s, the market has become less willing to stake early-stage companies with negative cash-flows – a phenomenon which should not be expected to reverse. The problem, it seems, lies not with the exit market itself, but with VCs ability to bring attractive offerings to the market. More…