As sandra manzke prepares to launch her start-up, she looks back at the changing face of hedge fund investing over the past 20 years
he investment universe has changed a great deal since Sandra Manzke made her make-or-break career leap into the brave new world of hedge fund investing.
As the founder of Tremont Capital Management, the specialist investment advisory house and probably the best known hedge fund index provider in the world, she stands out for many reasons, but particularly her working relationships with many of the the world's most celebrated and successful managers.
Now the hedge fund world has gone mainstream, with institutional and retail money flooding in faster than many managers can cope with and there is already talk of some kind of bubble in the market. But back in 1984, when Manske struck out on her own as an adviser and got her first client, the hedge fund world was small and secretive and often the problem was even getting to meet the managers.
Manske's client was a high net worth individual who had sold $100m of New York real estate and needed a replacement for all the rental income they had received. Hedge funds seemed the correct answer but no pension fund could invest in them. And to cap it all, there were very few to choose from: at that time, Manzke could only find 68 hedge funds in the world. "It was an exclusive club," she explains. "You had to get an introduction from someone else in the club."
Manzke asked a friendly law firm she knew to, in effect, write a letter of introduction and that's how she got her foot in the door of the mysterious world of hedge funds. Mysterious, and overwhelmingly male-dominated - another factor that makes Manzke stand out.
She said: "At the time, Wall Street was not a particular friend of minority groups and so ambitious women and African Americans would try to set up their own companies but could find no-one to invest in them." Manzke used this situation to her advantage, finding a niche market in matching investors with undervalued minority entrepreneurs looking for capital.
This prejudice might seem surprising in the hard-nosed world of investment, where one might think that only results matter. But these views were openly held. "There was a pervasive view at the time that women were money spenders, not money makers," recalls Manske. "Investment houses would explain to their female analysts that people would not feel comfortable having their money managed by a woman. And a lot of African Americans could not get jobs on Wall Street at all."
competition hots up
This situation has changed now with the far higher levels of competition to some extent squeezing out the luxury of being able to use questions of race or sex to make investment decisions. It is estimated that there are more than 6,000 hedge funds in the world, and that is according to a fairly strict definition of what counts as a hedge fund. One of the stars of the industry and, according to Manzke, one of the prime drivers of their popularity, was the legendary investor George Soros. "Soros was a huge contributing factor to the popularity of hedge funds, especially outside the US," said Manzke. "Firstly, he was very public and kept getting media attention and secondly, he only had non-US investors."
The fact that Soros only had an offshore vehicle gave him an nice double bonus. Aside from making him the favourite for Swiss private banks, it also allowed him to defer the distribution - and thus taxation - of his incentive fees for sometimes up to 10 years and the compounding effect significantly boosted his total revenues.
As the amount of regulation increased, it became very difficult for managers inside big institutions to run money in the way they wanted - there were limited trading opportunities because of conflicts of interest with other parts of the same company. "This was also the time of the great explosion in the size of the mutual fund industry," explains Manzke. "Everyone started pigeon-holing managers - a large-cap growth manager, a small-cap value manager. It took all of the creativity out of managing money."
Because of these restrictions, combined with Soros' high profile success and the fact that managers could make more money outside the company, many left to set up boutiques.
Both fund managers and investors have found hedge funds almost irrestistable. Fund managers are desperately eager to get the wealth available from a performance-based fee structure; and investors want access to the alpha-generating skills.
But popularity brings its problems. There are so many hedge fund managers out there that the opportunities they used to exploit simply do not exist any more - the markets have filled in the holes.
"The problem is that every style has its limitations - its capacity constraints," explains Manzke. "If you keep your style allocations the same and force managers to keep their styles pure, then you will lose out when the style underperforms.
"An example is convertible arbitrage," she says. Convertible trades are dominated by hedge funds and, up until recently, a convertible arb strategy could be relied on to return 12%. But now there is so much money in the sector and new issuance has come down so far in quality that spreads have narrowed significantly. And this situation could last a long time."
The spread of assets to successful hedge strategies is particularly noticable in the newer, faster-changing markets. In Europe, for instance, there has been a substantial flattening out of strategies in the last four years. Just five years ago, 50% of EU hedge assets were in long/short funds. That has now dropped to 24% (see pie charts) while the other strategies have caught up.
Manzke's view is that good managers should be able to use their imagination to move to different markets when returns are squeezed. "That is why I like hedge funds. I do not want to do asset allocation - I want to hire smart people. Other people worry about style drift but I love style drift."
And that sums up the difference between Manzke's attitude to hedge funds and that of many modern investors. Institutions and fund of fund investors can get very concerned about their own business risk. Investing in a maverick manager means you cannot micro-manage the risk in the portfolio but it is exactly that lack of predictability - the divergence from markets - that makes the good hedge fund manager worth their substantial fees. These are the managers that Manzke is looking to recruit in her new venture (see news page 5), the people she calls the OBGs - Oldies But Goodies; those who have been tested by time.
"These managers have all had years of big drawdowns but the recovery rate is astonishing," she says. In any case, she would much rather have an experienced manager who has occasionally had bad times than a new manager who has not had a chance to prove themselves.
She continues: "If a new manager comes out of a shop with no track record - I'll pass them up. And lock-ins: to accept a lock-in period when the manager has no track record is stupid. Go ahead, you be stupid, but not me."
Manzke is going back to her roots, choosing managers that she knows to create personalised products for her investors. "There are some very smart people coming out of universities," she concedes. "They are often very quantitative in their approach but managing and choosing hedge funds is an art form - it is a people business."
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