DIANE HARRISON 1

Hedge Habits To Leave Behind In 2018

Hedge Habits to Leave Behind in 2018

Before setting resolutions for 2019, December provides managers and investors with a good time to break
bad habits endemic to the hedge fund community. There’s no shortage of subjects where these practices
lurk, but here are five suggestions on habits to leave behind in 2018.

ONE: DON’T BURY THE LEAD OF THE ALTERNATIVES STORY: THAT AT ITS ESSENCE IT’S NONTRADITIONAL

I have heard numerous times from alternative managers and their sales support that one of the challenges
hardest to overcome in reaching out to prospects is communicating the role of alternatives within a portfolio
plan. Because investors typically find the instruments used in many alternative strategies, namely debt and
equity components, more familiar to them, the conversation turns to discussing particular segments of the
debt or equity markets used by the alternative strategy rather than how the strategy performs itself.

The CFA Institute Research Foundation summarized this issue in their 2018 paper, Alternative Investments:
A Primer For Investment Professionals (Donald R. Chambers, CAIA, Keith H. Black, CFA, CAIA and Nelson J.
Lacey, CFA}: Alternative investments include strategies that offer unusual risk and return characteristics
even when the securities underlying the strategy are traditional stocks and bonds. The returns of alternative
investments do not mimic the returns of traditional asset classes (stocks and bonds), and therefore, they
require specialized methods of analysis. The challenge for an asset allocator is to decide, as skillfully as
possible, which new types of assets to include in a portfolio and which to exclude.

Due in part to this, a challenge for providers of alternative strategies is to assist investors in a better
understanding of how a nontraditional alternative strategy works, how that impacts the traditional
components of a portfolio, and how best to integrate the two asset classes.

TWO: DON’T SHY AWAY FROM THE ‘R’ WORD—EMBRACE THE SUBJECT OF RISK AS AN ASSET

Another touchy subject for alternative sales professionals is the topic of risk. Alternative assets often carry
higher risk then traditional assets, but this is not necessarily a bad thing. There is a bias against
emphasizing risk with equal weighting to return, yet the relationship between the two is central to assessing
the value of any strategy, alternative or no. Many alternative investment strategies have been constructed to
take advantage of a higher band of risk in search of greater return potential, and these strategies can work
together with more moderate components of a portfolio to provide an overall enhanced result to investors.

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Hedge Habits To Leave Behind In 2018

Ronald N. Kahn authored a paper, The Future of Investment Management, for The CFA Institute Research
Foundation this year that states: Investment management is an inherently uncertain activity. Risk—the
distribution of potential outcomes—is unavoidable. But the approach to this uncertain activity is increasingly
systematic. Indexing and smart beta/factor investing are both very systematic. Pure alpha investing has
become increasingly systematic as the understanding has grown for the magnitude of the challenge.
Sustainable investing is often quite systematic.

One productive approach in discussing risk with prospective alternative investors is to educate them on the
value of quantifiable risk, downside protection, risk controls, and the like when presenting an alternative
strategy focus as a potential value add. The overall subject of disciplined, systematic approaches with
repeatable demonstrated results can work wonders to alleviate an investor’s negative bias toward strategies
with relatively high risk profiles.

THREE: DON’T MINIMIZE THE INHERENT OPACITY OF ALTERNATIVES

Another common complaint registered by investors about alternative products is the difficulty of obtaining
full transparency about the investment construction, how it’s doing, and how it impacts the rest of a
portfolio. Great strides have been made by the industry over past years with regard to this issue, with both
regulatory and industry improvements working together to ensure more complete, timely, and relevant
information provided to investors both large and small.

Despite the progress being made in industry communication, investors and their advisors share a
responsibility to increase their knowledge and understanding of alternative investments. The sales effort for
alternatives should address this dual effort for both providers and participants working towards a fuller
understanding of how these products can and should perform.

The CFA Institute Research Foundation paper, Alternative Investments: A Primer For Investment
Professionals, mentioned earlier also states: Alternative assets are often less regulated, more complex, and
private (than traditional investments). As a result, overseers of alternative assets often need to be familiar
with such issues as:

 safekeeping of assets
 pricing and settlements
 technology
 reporting and compliance
 familiarity with necessary investment parameters for derivatives, such as the International Swaps and
Derivatives Association (ISDA) Master Agreement, a service agreement for OTC derivatives that sets the
terms for both sides of the contract
 third-party service providers, and their function in overall administration and compliance issues .

FOUR: STOP TOUTING THE 2008 MARKET CRASH FEAR-MONGERING TALE

The alternative industry is not as nascent as it once was: indeed, there are decades of performance in which
individual investors have participated alongside their institutional brethren. We are now almost eleven years
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Hedge Habits To Leave Behind In 2018

beyond the 2008 marker in volatility, and hedge fund managers have grown over reliant on using the
episode to sell their alternative strategy.

The continued exploitation of investor fears— which spared few among the high net worth, pension and
endowment funds, as well as institutions—works against an effective education message centered on long-
term, full-cycle market investment in alternatives. Better to replace the scary 2008 crash scenario with
thoughtful, balanced time horizons of alternative investment holdings that define a long-view investment
attitude through up, down, and sideways market cycles.

FIVE: RESULTS: DON’T OVERPROMISE, THEN UNDERDELIVER

Since 2008, global sustained quantitative easing, with its historically low interest rates spurring quantitative
and passive investing, created a difficult environment for many alternative managers to make money. With a
massive underperformance record versus stocks, hedge funds on average have found themselves subject to
valid criticism about not living up to their performance promises.

This issue sparked a widespread call for reduced fees in alternative products over the past several years, as
investors rejected the traditional 2%/20% model on the heels of sustained underperformance. Managers of
all sizes were forced to shave their costs, reduce management fees, and increase fund liquidity in an effort
to keep existing investors as well as attract new participants. There was a positive side to this fee reduction:
marginal funds were forced to close, operating costs were closely scrutinized for efficiency and
effectiveness, and third party providers across all manner of operational support were galvanized into
existence. With outsourced support gaining favor from managers and investors for better transparency,
compliance and reporting, managers can rededicate their internal focus on the business of investment
strategy and differentiation, the core of their value, and accurately showcasing this ability.

Diane Harrison is principal and owner of Panegyric Marketing, a strategic

marketing communications firm founded in 2002 specializing in alternative assets. She has over 25 years’ of expertise in hedge
fund and private equity marketing, investor relations, articles, white papers, blog posts, and other thought leadership deliverables.
2018 AWARD WINNER: Acquisition International's Sustained Excellence in Specialized Marketing Communications - USA |
Corporate Insider's Excellence in Marketing Communications – USA. 2017 AWARD WINNER: Global Fund Awards 2017 Financial
Services Marketing Firm of the Year - NY, USA | Corporate Insider Business Excellence Awards 2017 Financial Marketing Firm of
the Year - USA | M&A Insider Awards 2017 Financial Services Marketing Firm of the Year - USA | Corporate LiveWire Innovation &
Excellence Award 2018 shortlisted. A published author and speaker, Ms. Harrison’s work has appeared in many industry
publications, both in print and on-line. To read more of her published work in alternatives, please visit www.scribd.com/dahhome.
Contact: dharrison@panegyricmarketing.com or visit www.panegyricmarketing.com.

PANEGYRIC MARKETING | DECEMBER 2018