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B. G., Opalesque Geneva: Thomas Zucosky, one of the true veterans of hedge fund investing, joins Opalesque founder Matthias Knab for a candid and wide-ranging conversation on four decades of financial innovation, hedge fund evolution, and investment philosophy.
Part 1 can be found here.
How institutions deal with hedge funds
Zucosky started Discovery Capital with a partner to help institutions figure out how to invest in hedge funds. In the late 1990s and early 2000s, he consulted with CalPERS, ABP, Citigroup Pension Fund, the World Bank and other institutions. At the time, institutions did not understand alpha.
Anecdotally, he says, "at a conference, the CIO of CalPERS made the joke that the institutionalisation of hedge funds hopefully did not mean that hedge fund managers were going to prison. And of course, we know that some of them actually did."
He has never been in favour of institutions' take on fees. He has argued with them that the best, as in sports, would not be taking less salary or less fees. "If they are truly the best at what they do, they're not going to give away their limited capacity in alpha production for a lower fee." He reasons that if beta, that is, the stock market, delivers 1% and the manager 2%, then 1% of their return is beta, the other is alpha, and alpha comes from pure skill.
He also has a problem with the way institutions look at alpha, as they see it as something you can add to a beta portfolio, "and juice it up." However, he says, alpha is not something that you take from the supermarket shelf and put in your shopping cart. It is a very rare thing. "When you see it, you grab it. And the reason you grab it as quickly as you can is because alpha tends to be arbitraged out. If the alpha is there because there's a dislocation in the marketplace, such as a supply issue in oil or something similar, eventually everyone finds out, and they take away the opportunities. These spreads were inherent in that dislocation. So, alpha is a rare thing. It is not a commodity."
No one-size-fits-all all for investing in hedge funds
Previously, an investor would find a hedge fund they liked and understood, give them money and leave them alone, looking at the statements once or twice a year. Now that hedge funds are more professionalised, investors look at the returns more dynamically.
The right way to be a hedge fund investor is the way that works for you, Zucosky says. With too much information, you could have paralysis by analysis and react too quickly. Some managers at institutions have told him they did not want all that transparency from their hedge fund investments, for if they failed to respond to all the information they get, they would lose their jobs. That is why private equity has become so popular, as these funds issue returns once a quarter or twice a year.
So the way you invest in hedge funds depends on your expertise, the amount of money that you have, and what you're trying to accomplish, he concludes. Furthermore, looking at hedge fund indices is not helpful as they use the mean of a data set, which does not represent the funds into which one has invested.
From FoHF to multi-strat
Funds of funds have more or less gone the way of the dodo bird thanks to the unpopular layering of fees. The FoHF managers were glorified marketing people - or concierges - who did not know what they were investing in, he says.
FoHFs have evolved into pods or platforms, the kind of multi-strategy hedge funds you can find at the likes of Millennium or Citadel. These multi-strat funds are single entities that act like funds of funds in the sense that they have multiple trading teams. These teams are employees who make their very own allocations. They are experts. They are given a lot of money - sometimes more than what their strategy can handle - and the returns are leveraged to be maximised. The risk controls are very tight and teams have little wiggle room. They can be fired for a 1% loss, as it can translate into a 10% loss with leverage. So the multi-strategy platforms handle large assets and can return double digits. Without the leverage, the returns would be single-digit.
As for the fees, the investors are charged a pass-through. The fees are used for rent, salaries, marketing, technology, etc. "It's not unusual for a platform to literally have a hurdle of low double digits before the investor makes any money at all."
"And if you talk to my friends in the multi-strat platform business, they'll say that it's been like The Hunger Games. It's where the industry is cannibalising itself. It's eating itself because all this money is being thrown at the best and the brightest. And when somebody leaves Goldman or Millennium to form their own hedge fund, all of a sudden, (the multi-strat platforms offer to) write them a check for a billion dollars. And then the other platforms are looking at them and saying, I can't compete with a billion dollars, I can only give you $100m."
You can watch the whole interview here: www.opalesque.tv/hedge-fund-videos/thomas-zucosky-lucidity-capital-partners/1
Investors from 30 countries are interested
Investors from 30 countries participated in a recent interactive Opalesque Investor Workshop: Multi-Manager Investing 2.0: How Lucidity Capital reinvented the model with Thomas Zucosky.
Here are some of the questions Tom addressed:
- As an investor, I like your TLC (transparency, liquidity, control) concept. It sounds like the holy grail of investing. So tell me, why isn't everyone doing it?
- What do you believe are the best measures of risk-adjusted returns?
- How will AI impact not only trading, but also the analysis of trading? Will AI negatively impact human trading talent? Or, will AI put you and other allocators out of business?
- Do you invest with emerging managers?
- How do you compete with the big platforms in retaining talent?
- Do you offer any customised mandates for Strategic partners or allocators?
- Which brokers are you using for the SMAs? Which PMS/RMS technology are you using to manage the portfolio in real time?
You can access the user-friendly video replay here: www.opalesque.com/webinar/index.php?id=82#pw82
Related article:
Perspectives from four decades of hedge fund investing - Part 1
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