I spend a lot of my time analyzing people’s portfolios through Orcam’s Portfolio Review process. That involves cranking their portfolio through a very granular analysis of their positions and various holdings. I take an entire portfolio and analyze its fee structure, its returns, its risk adjusted returns, back-test it, model it out, analzye various alpha contributors (if any), etc. The goal is to help provide clarity to the client so they can understand whether they’re positioned optimally or whether their holdings look good on the surface when there’s something evil lurking underneath.
Many of the clients are high net worth individuals who are invested in hedge funds. It’s always interesting when someone comes to you with a hedge fund holding because it can be more difficult to analyze than being handed a plain vanilla stock portfolio. And I see one rather alarming trend popping up over and over again. The funds I analyze appear to mostly have been cases of high flyer syndrome. That is, they had a good run over a few years or even longer when their asset base was small, but when you risk adjust the returns over the post-high flyer period the funds are an alpha drag. It often looks like investors are buying into past good performers, swamping them with assets and the funds are either overwhelmed by assets or just not as solid as most people thought. Alarmingly, many of the funds I’ve run through my risk adjusted return models are very well known names run by people we see all over the place.
That’s not to say that my small sampling of fund analysis is a sure sign that ALL hedge funds take more than they give (though, in the aggregate, that’s what most funds MUST do by definition of their high fee structure). I am certain that there are funds out there who generate value in more ways than one and can contribute positively to their clients’s portfolios. But I do see many similarities here with the mutual fund industry and the various reasons why mutual funds tend to be worse than most people probably assume.
In other words, be careful how you’re picking your funds and allocating your investments. What you see might be what you get, but it might not be all its cracked up to be. You have to deep dive into those returns to make sure they’re real value adds.