There are almost 10,000 hedge funds in the US alone. How do you sift, source, and allocate to the right mix of strategies and managers that will meet your investment goals?
WOA was pleased to invite Filbert Cua of Aetos for a master class on hedge fund portfolio construction:
How to source and evaluate managers?
How do different strategies work together (or don't)?
How to evaluate whether excess returns are due to skill or luck?
This webinar was recorded with permission on Dec 10, 2024.
Nothing in this webinar — or anywhere else in WOA — should be taken as investment advice.
AI Summary of the Webinar
Building Hedge Fund Portfolio Webinar
Jonathan welcomed everyone to the webinar on building a hedge fund portfolio, hosted by the World of Allocators and featuring Filbert Cua. He outlined the structure of the webinar, which included a presentation by Filbert, a fireside chat, and a Q&A session. Jonathan also introduced the World of Allocators, a non-commercial, not-for-profit community dedicated to promoting learning, sharing, and connectivity in the asset management industry in Asia Pacific and beyond. Filbert, a managing director at Aetos, then took over the presentation, discussing hedge funds, common strategies, and why they could make sense for institutional portfolios. He also planned to discuss issues in manager selection and portfolio construction and answer any questions from the audience.
Hedge Funds in Institutional Portfolios
Filbert discussed the role of hedge funds in institutional portfolios, emphasizing their potential to provide attractive risk-adjusted returns, diversification, and liquidity during downturns. Filbert explained that hedge funds can be a tool for both defense and offense during downside scenarios, as they tend to hold up better during downturns and are relatively liquid. They also highlighted the importance of expertise in managing hedge funds, particularly in underwriting downside risk. Filbert concluded by classifying hedge funds into liquidity-driven and skill-driven strategies, with the former providing short and medium-term liquidity and the latter generating more open-ended returns.
Hedge Funds' Role in Investment Portfolios
Filbert discussed the evolution of hedge funds, noting that their role has shifted from providing low-risk equity returns to offering risk mitigation. He emphasized the importance of understanding expectations and the need for hedge funds to justify their place in a portfolio. Filbert also addressed the impact of passive investment and ETF indexing on the hedge fund landscape, stating that while passive products provide beta at a lower cost, active management can still offer additional alpha. He suggested that increased passive flows could create more volatility in the short term, but provide better stock-picking opportunities in the medium to long term. Jonathan asked about the dynamic nature of the hedge fund landscape and how it might change over time, to which Filbert responded that the landscape has evolved due to increased competition and the rise of passive investment.
Manager Verification and Strategy Analysis
Jonathan and Filbert discussed the process of identifying and verifying good managers and strategies. Filbert emphasized the importance of understanding a manager's strategy in one sentence and analyzing returns both quantitatively and qualitatively. He highlighted the challenge of distinguishing between skill and luck in alpha returns. Filbert also stressed the need to consider changes in the environment that could affect a strategy's effectiveness. He mentioned the use of a proprietary database to track personnel moves at hedge funds and the importance of getting unsolicited references to corroborate or disprove working hypotheses about a manager's returns generation process.
Manager Selection Process and Data
Filbert discussed the manager selection process at a high level, emphasizing the importance of both quantitative and qualitative analysis. He noted that quantitative analysis, such as regression methods, is limited by the availability of data and can be noisy. He suggested that a broader base of return generation is easier to underwrite, as it reduces the likelihood of relying on luck. Filbert also mentioned that in some instances, qualitative analysis is used first, followed by quantitative work to verify the hypothesis. Jonathan asked about alternative sources of data and the role of AI in the assessment, but Filbert did not provide specific answers to these questions.
Standardizing Hedge Fund Data Challenges
Filbert discussed the challenges of standardizing data from hedge funds, which often provide inconsistent and incomplete information. He highlighted the potential of AI in speeding up internal processes, such as flagging outliers, but noted its limitations in providing exact data. Filbert also emphasized the importance of starting portfolio construction with the client mandate, balancing slow and steady liquidity-driven managers with skill-driven ones for a consistent base return and potential for extra returns. He used the analogy of an internal combustion engine to explain the desire for some hedge funds to be firing at any given time, providing an extra boost when they produce outsized returns.
Portfolio Construction and Manager Selection
Filbert discussed the approach to portfolio construction and manager selection. He emphasized the importance of understanding a manager's behavior under various market conditions and their ability to adapt to changing environments. Filbert also highlighted the importance of regular portfolio reviews to identify outliers and potential changes in a manager's strategy. He mentioned that they typically have around 10 to 15 managers in a portfolio, with the number depending on the client's mandate and desired diversification. Filbert also touched on the topic of emerging managers, suggesting that they should engage with investors early on to build trust and establish their reputation. Jonathan, the host, encouraged the audience to ask questions and provided an opportunity for Filbert to share his insights on emerging managers.
Platform Growth and Election Impact
Filbert discussed the growth of platforms with multiple pods and managers, emphasizing the importance of understanding each pod's risk limits and management practices. Filbert also shared insights on the market's response to the election, noting that fund managers generally fared well but highlighted the importance of prudent risk management before the election. Filbert suggested that keeping dry powder after the election could allow for more informed long-term portfolio adjustments based on potential regulatory changes or administration priorities.
Multi-Strategy Investing and Risk Management
Jonathan discussed the role of multi-strategy investing, including pod shops, quant shops, and crypto funds. Filbert explained that multi-strategy funds aim to create an all-weather portfolio with a balance of downside protection and consistent alpha generation. Filbert also noted the trade-offs between capital efficiency and individual manager skill, as well as the liquidity provided by these funds. Filbert suggested that pod shops and platforms are somewhere in between single-strategy funds and multi-strategy funds. Filbert also discussed the role of quant shops, noting their potential as a welcome addition to portfolios due to their systematic approach. However, Filbert warned about the risks inherent in some of these strategies, especially those with leverage. Lastly, Filbert admitted to not being an expert on crypto funds but suggested that they could be a part of a portfolio if the investor is willing to take the risk.
US Equities and Emerging Markets
In the meeting, Jonathan and Filbert discussed the performance of US equities and the potential for adding to or redeploying to China or emerging market equities. Filbert explained that their focus is on stock-specific dispersion rather than market movements, and they see opportunities in China and emerging markets due to their ability to capitalize on stock dispersion. Filbert also emphasized the importance of being honest with clients about the role of hedge funds in a portfolio, whether it's as a diversifier or risk mitigant, or as a growth driver. The conversation ended with Filbert offering to answer any follow-up questions via email.
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