Tough Minded Investment Manager Analysis

The hedge fund and alternative investment industries have matured in most ways over the years.  A modest number of people now make their living performing due diligence, for example, some of them doing a reasonably good job of it.  When I started in this industry, quality due diligence consisted of asking, “Does anyone here know what Frank Pusateri thinks about this fund?”  In at least one way, however, the industry has seriously degenerated.  Presentation data used to be much, much better.

A few days ago, I reviewed the data available from the leading hedge fund and CTA data vendors.  All of the data I saw was in what I call two-and-a-half column format.  The three columns are date, amount under management, ROR and VAMI.  Once you know the fund’s name and date, which are rarely considered proprietary information, you really only know two things about performance.  VAMI does not add any new information.  The vendors provide this information because this is what their customers want.  Besides, this is all of the information most funds provide.

This is not all of the available information, however.  The once popular, four-column format presented the beginning equity, equity introduced, equity withdrawn and ROR.  The additional equity information makes a big difference.  A large (or small) monthly ROR can be as easily caused by change in equity as a change in earnings.  Even better is what I call the CFTC’s thirteen-column format. The thirteen-column format presented four-column data plus realized profits, change in unrealized profits, interest earned, management fees, incentive fees, brokerage and other fees and still more.  The additional information allows the investor to refine his analysis.  No, that is not strong enough.  It is simply not possible to fairly compare two hedge funds without adjusting the accounting numbers and this just cannot be done without using thirteen- column data, at least.

This is not a new idea, by the way.  If memory serves, Jack D. Schwager wrote about these issues in Managed Trading: The Myths and Truths more than fifteen years ago.  This book is no longer in print.  Not his fault.  As I said, the industry has regressed here.  I am not completely sure why these standards have fallen out of practice.  Part of the answer is that investors do not demand it.  Part of the answer is that data vendors do not collect this data.  It used to be expensive to collect.  But cost is no longer an issue.  In order to prepare monthly RORs, all of the other data has to be collected and recorded anyway.  Publishing this data electronically should be relatively easy.

When you are comparing one CTA with another, the thirteen-column format is almost enough.  When you are comparing one hedge fund with another it is not.  The problem here is in the change in unrealized profits column.  Investors need separate columns for investments that are market to market and investments that are priced in other ways.  It should be relatively easy to divide investments into these two groups.  I can see the value, theoretically, of separating investments that are marked to model from those that are marked to myth, but I am not now convinced the work is worth the effort.

Finally, we need an audit column.  I have never seen a vendor database which treats audit data properly. Vendor databases invariably treat audit information as a constant.  It is not.  It is a variable that should contain the name of the audit firm and the name of the auditor if the audit is hand signed, which it should be.  Another column should state where the audit was signed.  Accounting rules vary radically from country to country.

Returns from hedge fund and other alternative investment managers have dropped over the last few years, which means that power is shifting from managers to investors.  Investors need to demand such information from their managers and from their vendors.  I would go further, however, and suggest investors demand the SEC/CFTC require CTAs/hedge funds provide such information in electronic form, if not as part of disclosure documents. I am not generally in favor of regulation.  The SEC killed a friend of mine, in a sense.  My friend ‘Jake’ used to work 60 hour weeks as a matter of course.  Then the SEC hit him with a request for information and my friend worked himself to death.  I sympathize deeply with investment managers who do not want their work load increased.  But investment managers are not always underpaid and as the comic character Chicken Man used to say, “You knew the job was dangerous when you took it.”