Large CTAs underperform for 5 years

Not only the multi billion dollar CTAs underdelivered over the last 5 years, many of the other multi billion dollar firms did so too. This seems to be the reason why following the year-end analysis of 2016, the amount of investments into smaller managers and the interest in them has increased substantially.

We see all this as a natural progression in investor sophistication enhancement, which is comparable to the long only world, where investors started with mutual funds and then progressed to do more active management themselves via low cost ETFs, believing that their active management skills are better or accepting index performance as good enough. Now many are accepting that low cost and index hugging alone will not do the trick either.

In hedge funds the progression is comparable: the initial move was into fund of hedge funds, with most investor attention on due diligence and performance and very little interest in the underlying single manager names. Following Bernie Madoff this changed and investors started asking about single manager names and due to this realized that many Fund of Funds had allocations to the same large managers. They then simply invested in the large names themselves and skipped the Fund of Funds entirely by copying what they believed to be the best approach to hedge fund investing. Now they realise that size alone is worth little, since managers are struggling to continue to deliver their past returns, now that assets have doubled, tripled, quadrupled etc.

By having invested in single managers for many years now, experienced investors have little issue in progressing with smaller managers since they are comfortable with what they define to be a well run business. And since the pressure to perform is increased by the low interest rate environment, and the memories from 2008 that equity downside can hardly be escaped via cheap ETF long only exposures (net of fees -40% is still -40%, and the basis points saved vs. more expensive options will heal wounds very little), the search for best net of fees performance continues in different waters.

In general these are healthy developments. Large private banks for example are increasing their Hedge Fund target allocations to 20%, which will put even more capacity pressure on the already too large managers and will naturally focus their attention on the next-in-line manager options (the smaller ones with better performance). The realisation that Private Equity downside and Real Estate downside will be highly correlated to equity market downside and that fixed income might be the wrong place to be in case we all get a continuation of the improvements that we continue to hope for, makes liquid alternatives a more and more appealing option to diversify properly for many.

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