Hedge Funds Change as Investors Favor Lower Returns Over Volatility

“Investors want something different than they got 20 years ago,” according to Howard Marks, ’69. “They used to look for risk. Today people are looking for limited risk and exposure.” Marks, chairman of Oaktree Capital Management, LLC, was among panelists who debated the future of hedge funds at Management Conference at Gleacher Center May 19. The discussion was moderated by Tobias Moskowitz, Professor of Finance and Neubauer Family Faculty Fellow.

When hedge fund investing began with a handful of companies 30 years ago, it was common for investors to see a 200 percent return, according to Richard Elden, ’66, founder and chairman emeritus at Grovesnor Capital Management, L.P. Volatility was the name of the game, he said.

But now the “game has changed,” said Clifford Asness, MBA ’91, PhD ’94, founding and managing principal of AQR Capital Management, LLC. “Now 12 percent is great,” Marks said. “What changed is prices fell.”

According to Elden, people are trading performance for lower risk. “One of the most interesting things is volatility,” he said. “Investors may be playing it too safe. Lack of volatility has become so highly prized, it’s defeating the managers.”

There are two ways to make money with hedge funds, said Asness, and one is the skill of the manager. (The other is in nontraditional strategies.) “You should invest in the skill of the manager; it’s important in funds to break that out from stock index investing.”

If investors trust the manager, they will assume more risk, and see higher returns, Asness said. “There’s something to be said for volatility.”

But these days, said Marks, “Managers want to be paid just for managing rather than for performance.” They have come to rely on the fee structure, traditionally 2 plus 20 percent for hedge funds, rather than investing well, he said.

However, the situation could change as money flows into hedge funds from such institutions as endowments and public and corporate pension funds. “Institutions are coming to hedge funds so prices will go down,” said Asness. “The balance of power has been with the hedge fund, but institutions may force lower fees; the balance of power will shift.”

The other difference institutions are making is in hedge fund governance transparency. “They are pulling for transparency,” Asness said. “They’ll get what they want over time.”

—Carmen Marti