There’s an old joke about two guys walking in the woods. They spot a bear running toward them, and one guy sheds his backpack and starts to run. The other guy screams, “What are you doing? You can’t outrun a bear!”
Without stopping, his friend yells back: “I don’t have to outrun the bear! I only have to outrun you!”
Add “market” to “bear,” turn the two guys into hedge fund managers, and the old joke is au courant. Managers today don’t necessarily have to outrun the bear to survive, but they do have to beat the competition.
That’s because the hedge fund industry is awash in redemptions, and the wave shows few signs of subsiding. Investors are pulling money from poorly performing funds and better-performing ones alike. To some extent, these redemptions are the result of a broad liquidity crisis, as investors cash out of holdings to cover other obligations. But that’s not the whole story.
Many investors have bailed out of funds simply because they’ve become uncomfortable with the people running them. More than ever now, investors are looking for a great deal more than the vague promise of returns — they want to be confident that managers will keep them posted about what’s going on with their investments and take the time to explain the ups and down of their portfolios.
The solution lies in proactive communication and openness, characteristics that historically have been all too uncommon in the hedge fund industry. Key areas of concern are overall transparency, risk management, personnel changes and asset shifting. By falling short of full, or at least reasonable, disclosure in these departments, managers increase the odds that they will be singled out when an investor finds himself or herself in the position of having to sell something to raise cash. If and when an investor asks a question, a manager should be able to supply a quick and honest answer.
Almost every manager will have drawdowns, but those who try to live on performance alone while maintaining a passive or even negligent approach to client service are destined to lose more investors than their rivals do when the hard times come.
Effective communication should include at least quarterly explanations of investment strategy and risk controls that also detail as much portfolio transparency as possible without compromising strategy. Good proactive communication also outlines the rationale behind a particular position by explaining, for instance, why shorting oil or technology stocks at a certain point in time might be a better idea than going long.
Letters can be written and e-mails dispatched, but the strongest way to ensure that the message sent is the one received is to deliver it in regular face-to-face meetings that allow for immediate give-and-take and grant managers the chance to handle investor questions or qualms head-on. A two-way sit-down lets managers go beyond arcane spreadsheets and charts and explain the fundamental themes underlying their investments.
This strategy can help guarantee the long-term survival of a manager because investors are far more likely to exit a fund or a strategy they don’t understand; confidence is one of the products of interpersonal relationships, and the sharing of knowledge can give investors a legitimate sense of partnership. Pension fund managers do not want to have to explain to their boards, for instance, why they held an investment that posted negative returns unless they have been versed on the potential for that position to appreciate.
Of course, one of a manager’s many challenges is putting the right person in front of a client or clients. Hedge fund investors may meet with more than 100 managers a year, and few investors are going to completely understand the intricacies of all of their investment and risk control processes. The more complex the strategy, the more important it is to communicate.
The goal is to deliver a message that is both informed and lucid, a job sometimes best left to someone other than the portfolio manager, whose focus is rightly devoted to investing. On the other hand, rolling out what may be perceived by an investor as only a marketing dog-and-pony show misses the point.
The ticket here is to keep investors informed without distracting from a hedge fund manager’s main job, which is to ensure investors a good return on their dollar.
Patrick LeBedis, managing partner of Oak Bay, and William Lloyd, a managing director of Coral Bay Capital, are senior advisers to the Alternative Asset Group of CJP Communications, a New York–based public relations firm.
