The following post is courtesy of Diane Harrison who is principal and owner of Panegyric Marketing, a strategic marketing communications firm founded in 2002 specializing in alternative assets.
As 2023 draws to a close amid political volatility around the globe, the investment community will be mulling over how to determine defensive positioning for the months ahead. It seems apt to consider this time a means of financial dead reckoning, or determining where you stand based on the current environment, before deciding how to proceed. Here then are some factors to consider on the investment horizon.
Earning Outlook: Companies are judged on their ability to meet, beat, or fall short of earnings expectations. Analysts will ponder who wins, who loses, and why. Everyone will be measured against this yardstick, and, inevitably, hedge fund managers will be judged on their ability to deliver performance, net of fees, from investors if returns don’t measure up.
The Perennial Hot Button, Fees: Rather than trumpet the media perspective so often touted, that of investor angst, let’s look at it from the side of the alternative managers earning their keep. Managers feel the pressure to lower fees, but are they really the problem? Rather, let’s focus on the nomenclature that accompanies hedge fund returns: ‘net-of-all-fees.’ Four words that level the playing field amongst returns, but are often ignored in a rising tide of aggravation over funds performing under par. Hard-working hedge fund managers who actually do what they claim to do, which is beat their appropriate benchmarks, should stand up and be counted.
Professional Service Is A Paid Skillset: Alternative assets are meant to provide a means of obtaining performance above the levels obtainable through conventional, and generally less-risky, assets. I’ve covered this before: To generate outperformance, a manager must either do only more of what’s positive, or mitigate the risky downside that often accompanies outsize returns. If downside risk counteracts upside gains, subpar performance results, which can include matching or marginally beating a benchmark. Managers who fall into this category will effectively be punished through redemptions or lack of new capital flows. If outperformance were easily achieved or obtainable from conventional investment sources, there would be a far smaller universe of alternative investment options, as investors would seek value within traditional sourcing.
You Get What You Pay For: The value proposition for alternatives remains—to provide a means of obtaining performance different from other assets, which complements or enhances an investor’s overall investment goals. Investors have a wide range of options to construct their unique solutions, with alternative investments providing a component to any portfolio. The premium in paying up for this type of investment category is mitigated by the convention of measuring alternative investments by their net returns. It shouldn’t matter what fee an alternative manager charges when, net-net, the alternative manager delivers on the return objective.
To restate a conclusion I have held for many years, and which I believe is as true today as it was in 2013: to those critics who clamor for alternative fees to come down across the board, and ‘level the playing field’ for investors comparing alternative investment options, I submit that the hedge fund universe, like most things in life, is not a level playing field. It’s a meritocracy, where quality of performance counts. Managers shouldn’t be afraid to defend their value. Investors should expect to pay for performance returns above the benchmarks. The competitive reality in which both sides exist will ensure that managers worth their salt will succeed, and those that are exposed for not adding value will fade away. But the fees are not the issue; perception is clouding the reality of the process.