Friday, 14 December 2007

A sensible fund manager speaks

Maybe it is because he is from a a predominantly passive house, but I've always thought Lindsay Tomlinson talks a lot of sense. In this interview on Thomson he has a pop at hedge funds, in particular because people are paying a lot of money for beta (market performance):

AMSTERDAM (Thomson IM) - The current market crisis will unmask hedge funds's true investment structure and show that investors have often bought significant "unexpected" beta at a high price, according to Barclays Global Investors (BGI) vice-chairman Lindsay Tomlinson.

Tomlinson said: "Events will reveal their (hedge funds) true position, we do not even have to wait long."

"August was a horrible month for hedge funds and in November every single hedge funds had negative returns, beta exposure is becoming manifest as we speak. This is a case of misunderstood, overpaid beta," Tomlinson told delegates at the Multi Pensions 2007 conference here.

Stressing that he was giving a personal view, rather than that of BGI, Tomlinson compared the typical hedge fund to an iceberg, where investors could only see a small aspect of a larger structure. Alpha, he argued, is the tip of that iceberg.

"Ninety pct of it is beta and it is what most of us can't see," he said.

"You pay through the nose when you can get beta in other ways. Beta is cheap, it can be bought at lower costs than 2 pct and 20 pct," the average hedge fund's management and performance fee structure, he told delegates.

"The amazing thing, almost the unforgivable thing is that these mistakes have been made before, 20 years ago with long only managers. People used to think that if the market returned 20 pct and the long only manager 19 pct it was still a good job.

"Amazingly, the same thing has happened in hedge funds and most people have not understood that," he said.

Tomlinson also criticised the trend to invest in private equity and other illiquidity assets. He said that in principle it makes sense for long term investors such as pension schemes to tie up resources for a long time and be rewarded for it, but he argued that schemes are now being "pushed" because of their obligation to demonstrate solvency against marked to market assets.

While investment in liquid assets must be measured against market conditions the value of illiquid investments can only be assessed through models, what Tomlinson called "marked to make believe".

He urged investors to "hold illiquid assets for the right reasons [and] not just because the marked to market valuations will be less volatile," as he forecast a slowdown in business, especially in the private equity field.

"Six months ago this was the new paradigm; private equity needs public markets and vice-versa. It was the new 'new thing'. It is a symbiotic balance, but where is the balance?

"Now it is very quiet, private equity managers are in their bunkers awaiting the big bust," he said.

Speaking to Thomson Investment Management News on the sidelines he said: "One of the main issues is that investors worldwide may not know what they have bought, and it is likely that there will be a risk appetite reappraisal."

"Probably people did not have the risk appetite in the first place and bought stuff where they did not understand the risk implied. If they had fully understood the risks they would have not bought them in the first place," he said.

This expected risk reappraisal, however, will not bring an abrupt halt to allocation to alternatives, he said.

"Hedge funds will carry on growing but they way we think about them is going to change. They will be thought of more in terms of stripping alpha from beta and when [investors] start thinking in that way they will find that there is much less added value in the industry than it has been represented in the past," he said.

"Investing in beta and investing separately in alpha is the right paradigm," he said.

"Those who will prosper in the long run are people who will be able to add value, that means by pure alpha. There is a trend globally of increasing speed and transparency and it perpetually flushes out the elements of the system which are only cost with no value, that is going to continue to happen," he added.

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