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Alternative Market Briefing

Opalesque Webinar: So, when should you exit a manager?

Friday, March 13, 2020

Cedric Kohler
B. G., Opalesque Geneva for New Managers:

BlackRock Multi-Sector Income Trust recently fired one of its fund managers for conflict-of-interest after that manager loaned $75m to an indie film studio that cast his daughter in one of their movies, according to The Daily Mail and other papers. That is, for one, an unusual yet valid reason for firing a manager. Managers' reactions to the pandemic and the ensuing stock markets' freefall might be another. But what are the most common reasons for doing so?

Before you fire a manager, you need to define your performance success criteria, according to Cedric Kohler, partner at Fundana, a Geneva-based fund of hedge funds manager.

Do you have an absolute return target in mind or is it a relative to a benchmark, a portfolio or a peer group? How much of the performance should come from alpha versus beta? How much of the returns come from longs and from shorts? How much of the returns come from specific factors (such as momentum, growth, etc.)?

Furthermore, "every manager goes through a life cycle, and you need to be able to anticipate how things are going to turn out," he says during a recent on manager selection.

The typical reasons to fire a manager are:
- Change of manager
- Style drift
- Changes of terms
- Legal action
- Concentration ratio

As well as:
- Inability to understand performance drivers
- The portfolio becomes illiquid
- Rapid AuM growth. "Anything that grows to fast will be completely disrupted. We like to see our managers pause and digest growth by looking for other stocks, hiring more analysts, etc."

In general, try to look for anything that could change the portfolio manager's focus." It could be simple things like their organisation becoming more complex by for example managing more vehicles," he adds.

Manager selection is key

In the hedge fund world, there are challenges to sort through: a high degree of luck, a high degree of dispersion and a performance that is not usually persistent. So manager selection is key, he says.

Focusing on manager performance only does not allow allocators to differentiate skill from luck. Also, the performance numbers are not usually real. And beware of what looks too good to be true.

Looking only at the investment process is also a challenge. All of them make good sense. But one must be aware of manager behaviours, see how they will react to a market correction and a fund drawdown. What is portrayed on paper does not usually translate into reality.

As for themes, they always sound great, he continues. But "there is a world of difference between a great theme and a great performance. So we try to put that aside as much as we can."

Fundana's approach can be summed up as such: "We prefer facts over speech." It centers around three pillars:
(1) discover talent early (preferably more simple set-ups with a minimum of $200m);
(2) control the downside (with risk management tools and operational due diligence);
(3) ensure the upside (breaking down sources of performance and risks of AuM dilution).

Kohler wraps up by reminding us of the value of funds of funds (FoFs), the fallen funds of 2008. FoFs did not always add value before the crisis, he says. But a lot of clean-up has been done since then. Nowadays FoFs still make sense to some investors, because through FoFs, they get access to new managers; minimum investments are lower; FoFs have expertise and resources, such as dedicated staff and operations. FoFs can also provide special research for strategies that have high dispersion, as well as diversification with lower risks, and fee negotiations.

You can listen to a recording of the Skills lab webinar, Rethinking manager selection: skill or luck? (about 60 mins) here:

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