Hedge fund ‘beta’ should be cheaper, says hedge fund manager

Returns generated by well-established hedge fund strategies could be categorised as ‘hedge fund beta’, and manager fees correspondingly lowered, according to Gregor Andrade, AQR Capital Management vice president.

Andrade’s comments were accompanied by other – often critical – viewpoints examining the fees charged by alternatives managers during a panel session at the Absolute Returns Funds 2007 conference in Melbourne last Thursday. More than 200 fund executives, consultants and managers attended the event, organised by Investment & Technology in conjunction with the Alternative Investment Management Association (Australian chapter). Andrade said that many hedge fund managers were deriving returns from well-known trading strategies and classifying them as alpha. He cited merger arbitrage, a hedge fund strategy in which managers invest in both the acquiring and target companies amid merger speculation, typically going long the target and short the acquirer, as an example. But with this strategy, managers provide real alpha by correctly judging the probability of the outcome. “Their skill is picking which deals will not blow up,” Andrade said. AQR had researched all proposed and completed mergers that had occurred in the US since 1960. From this, the firm calculated a benchmark return and concluded that if a manager used merger arbitrage as a passive strategy, they would generate a Sharpe ratio value, which denotes their risk-adjusted performance, of 1.5. “Most of the returns are coming from a strategy that can be replicated systematically. How much should you pay for this?” Andrade said. Investors should pay different fees for traditional betas, such as equities and bonds, as distinct to betas drawn from established strategies, including those used by hedge fund managers, and manager skill or alpha, Andrade said. “There should be three types of fees.” Also speaking during the session, Tim Hughes, Catholic Super chief investment officer, reproached private equity managers for charging high fees. He said the high base fees were not aligned with the interests of investors, adding that Catholic Super had not allocated to private equity in the past three years. “Hedge funds provide absolute returns and diversification, so it’s worth it. Private equity is a remuneration package dressed up as an investment strategy,” Hughes said. “Are you getting something that you can’t get from the public markets? Because you will pay high fees [for private equity returns].” Private equity manager fees were also being mirrored in other alternative asset classes, such as infrastructure. “All the easy returns in infrastructure have been eaten away and fees are going up.” John Nolan, Warakirri Asset Management executive director, said investors should primarily consider manager skill since fees were a peripheral concern. “To focus on fees is to potentially miss the main game,” Nolan said. “When selecting a manager you are likely to make better manager selection decisions if you ignore both historical performance and fees. If you cannot decide between two managers – compare their fees. “The fees for high quality investment products that are priced around average are cheap.” In addition to undertaking or buying quality research on managers, consideration of the probable future environment in which they could be operating would also be prudent. Nolan said that Warakirri’s three Australian equities multi-manager trusts set relatively high fees since they pay underlying managers well. If the trusts outperform, Warakirri receives a performance fee, in addition to a base fee, that ranges between 10 and 20 basis points. The highest-paid underlying manager had outperformed by more than 5 per cent. Furthermore, paying managers for outperformance would be most fairly carried out if returns were measured against customised after-tax benchmarks. “Net after-tax returns are what superannuation fund members eat. To fully align the interests of managers and their super fund members, mandates need to be awarded on an after-tax basis.” In July, Warakirri converted 22 Australian equity mandates to an after-tax format. Hughes added that private equity managers charged fee levels based on those set by American managers. “We’re dealing in global markets for this. The US overpowers ours and they’re the price-setters. Jon Glass, founder of alternatives investment advisory firm FineAnswers, said that the growing clout of super funds could be drawn on to negotiate lower base fees with alternatives managers.