On CNBC’s website today:
On CNBC’s website today:
Last week Ford (F) announced plans to shift their pension fund even more heavily towards bonds. At a time when interest rates are ruinously low and equities should appear attractively priced to a long-term investor such as a pension fund this represents quite a radical move. As recently as 2006 the company had targeted an equity allocation of 70%. Generally pension obligations are long-lived and one would expect pension funds to be more tolerant of equity market volatility in their quest for higher long-term returns. However, Ford’s stance probably reflects an acknowledgment of the inherent cyclicality in their own business; if they had a higher equity allocation in their pension fund, it would likely be most under-funded during a weak equity market which would coincide with a tough automobile market, perhaps stretching Ford’s ability to inject additional cash to meet a projected shortfall. It’s part of a plan to reduce the risk of their overall balance sheet. Nonetheless, the reaching the 7.5% return target (reduced from 8%) on their pension assets appears challenging with 80% of their assets in fixed income, and the company is currently facing a $15.4BN shortfall on such obligations. Today’s yield curve is a long way short of delivering adequate returns, even with the other 20% of their pension assets invested in “growth assets (primarily alternative investments, which include hedge funds, real estate, private equity, and public equity)”. Naturally I should point out that hedge funds may wind up underperforming even their fixed income allocation if past history is any guide.
But it does illustrate an alternative to the concept of overweighting equites to meet pension obligations. Ford is in effect relying on strong operating results to generate additional cash contributions (which will surely be needed). The decisions they’ve taken are consistent with an analysis showing that their business prospects will generally be tied to those of the overall economy and therefore public equities. So rather than invest directly in diversified equities that will (they assume) correlate with Ford’s own results, they are relying on their own equity-like business prospects to generate needed future cashflows. It’s quite a clever strategy. They reduce their balance sheet risk and the volatility of their pension obligations. The worst scenario is one where Ford’s results are dismal while the economy is doing well, perhaps driving up their ultimate obligations at a time when they’re ill-equipped to contribute more needed cash. But they may have calculated that retiring Ford workers will earn pension tied to their pre-retirement earnings, again mitigating their risk.
Ford’s approach represents an intriguing approach to the pension shortfall common to many S&P500 companies.
In recent years as hedge fund performance has become ever less appealing, the industry has responded in part by changing the way it describes itself (much cheaper than cutting fees or delivering better results). So when Absolute Return outlived its utility, since many funds were unable to deliver positive returns in excess of treasury bills no matter how long they were given, some managers claimed that their objective was to deliver Relative Returns. That is, while their returns might not be positive they could be relatively better than other asset classes. This was a handy move prior to 2008, because returns were very definitely not positive but were less horrendous (i.e. relatively better) than equities.
More recently, Uncorrelated Returns has gained favor. This was another smart move just in time for 2011’s results, because while returns were definitely not positive (i.e. Absolute Return wouldn’t have been an appropriate moniker) or even relatively good (since they were worse than virtually anything else you could invest in) they were definitely uncorrelated. This could be a good long term choice, because uncorrelated just means they don’t have to look like anything else you own, which could encompass quite wide set of investment outcomes.
I just came across another term though, Smart Beta. This was used (for example) in an article from last year and although there is no photo of the author’s face when he wrote it I believe it is intended to be taken seriously. Perhaps it is meant to evoke Smart Bombs, which unerringly reach their target through computer driven guidance. In fact, bombs is a useful if unfortunate connection to use in this context.
But then everything was cleared up by Zilch Capital, a hedge fund that is evidently moving quickly from relative obscurity to complete oblivion and whose latest marketing letter was kindly reproduced in the Economist. Ah well, the hedge fund industry is a soft target. As Warren Buffet once said, if you don’t kick a man when he’s down when will you kick him? They’ve tried Absolute, Relative and Uncorrelated. Perhaps it should be the Zilch Return industry.
Alistair Blair of Investors Chronicle provides an additional perspective on my book, The Hedge Fund Mirage, in an article out today. Mr. Blair has gone to the trouble of asking The Alternative Investment Management Association for a response. One of their Core Objectives is, “To provide an interactive and professional forum for our membership and act as a catalyst and promoter of the industry’s global development.” You might imagine that a book noting the enormous imbalance between the results for hedge fund managers compared with their clients would command AIMA’s attention. If it has, the result must have been rather more time spent on internal discussions of damage control and rather less on quantitative analysis, at least based on their response to Mr. Blair.
AIMA’s opportunity now is to acknowledge the embarrassingly poor past economic outcomes for clients of the industry they promote, and to lead the discussion of how hedge fund investors might access the undoubted talents of many managers on far more equal terms than in the past. Will they be up to the challenge?
On August 8, 2011 Andrew Baker, CEO of AIMA, proudly noted on FTfm that, “Far from being disappointing, hedge fund performance has been impressive.” This was in response to an article by Jonathan Davis whom Mr. Baker accused of promoting “hoary old myths about the hedge fund industry.” Jonathan Davis was on to something, and Mr. Baker’s vigorous defence of his industry (albeit at odds with the facts) happily did not deflect Mr. Davis from shining a spotlight where it was sorely needed. Fortunately for investors he followed up a few months later with the pointed, “Do hedge funds offer value for their fees? No.”
Six months after Mr. Baker’s “…performance has been impressive” comment, AIMA is still avoiding a response that includes numbers and now lamely speculates that, “The main problem with Lack’s whole thesis is that no serious investor would tolerate for long a situation in which nearly all the returns were going to the manager and not them.” I think I shall start wearing AIMA’s criticisms as a badge of honor. Somebody ought to be promoting the interests of the clients – there doesn’t seem to be much competition for the job.
Bloomberg TV invited me back on this morning – the sorry results of hedge fund investors are just too incredible to be believed and so they asked to produce a chart illustrating how fees have been split. It turns out that if you calculate how much money hedge funds generated BEFORE fees from 1998-2010, and then deduct hedge fund fees (and fund of fund fees) from the gross profits (that is, in excess of treasury bills since those are the only measure of returns that are worth anything) , the clients were left with 2%. Hedge funds have been highly profitable, but unfortunately the profits haven’t made it to the investors. Anybody can do this calculation – the methodology is simple, is explained in my book (The Hedge Fund Mirage) and has not been seriously challenged by anybody.
The industry kept 98%. Bloomberg presented a version of this chart on TV this morning. Hopefully the message is getting across. It’s not that there aren’t some great hedge fund managers out there – of course there are. But investors need to do a far better job of negotiating terms that allow them to share in that success.