Speaking at the recent World Cup of Investment Management conference in Barcelona, Mr Backström said that investors should make sure they compensate hedge fund managers adequately both for alpha and beta.
He said: “You have to ensure you don’t pay too much for beta, while not expecting to get too much alpha for a small fee.” He explained that the fees investors paid should reflect the returns they get and where they have come from. “You should put your effort into evaluating fees, but you should also spend time assessing the alpha-creating possibilities of the managers. You should also make sure you understand the beta exposure you are getting,” he said.
Mr Backström noted that beta exposure is the most difficult element to assess because, even if the manager knows how the returns are being generated, he would probably rather say they are coming from pure alpha when the reality is that often they are being generated from the beta exposure of the portfolio.
“Worse still, the manager himself might not even know where the return is coming from,” he added.
This assessment is an important factor to take into account when choosing a hedge fund manager, a process which differs from the selection of traditional managers. “The most important criteria remains the same – people, process, price – although the emphasis might be slightly different,” he said. Investors should take into account that the beta exposure of hedge fund managers can be more dynamic and therefore more difficult to pinpoint. Also, alpha is generated using a bigger toolbox than that of traditional managers.
Mr Backström added that in order to adequately evaluate alternative managers, investors needed to look at the risk of the investment not only in isolation but also as part of the total portfolio.
With the universe of hedge fund managers continuing to expand, both choosing the right partner and analysing their performance is becoming trickier. A recent report by Mercer Investment Consulting says investors need to be clear on the appropriate benchmark to use to judge hedge fund managers.
Mercer also recommends that those investing in hedge funds to get used to asking more questions and spending more time on operational due diligence, since recent industry scandals have proved that even the more sophisticated investors can be caught off-guard.
PG
