The Future Fund's Annual Report 2018 shows it has increased allocations to index funds, but some active managers are justifying their fees. It says:
"We remain willing to support active management where we are confident that a manager can reliably add value net of fees. The commitment to genuine diversification is an important facet of our investment strategy and has been beneficial to the Fund's overall performance delivering strong returns net of costs while reducing volatility.
We are therefore more willing to pay higher fees to our investment managers or areas where significant value is added over broad market exposure (such as private equity) or for exposures which are truly diversifying (such as hedge funds)."
Question: When is a hedge fund not a hedge fund? Answer: When it has almost as much exposure to equity markets as a traditional long-only fund manager. It does little to diversify risk.
A few weeks ago, I attended the Alternative Investment Management Association (AIMA) Annual Conference. They are not overly fond of the term 'hedge fund'.
An example at the conference of a hedge fund seeking genuine diversification was Two Sigma and its search for 'uncorrelated alpha'. They combine over 10,000 data sets with industry-leading computing power, believing "the tiny data within the noise matters". One data set uses satellites to count cars parking at Walmarts to monitor store turnover. They proudly boast 72% of new recruits have no finance background, as the best way to find uncorrelated returns is to be different.
There is no way investors in such funds will know what the traders are doing. It's a matter of trusting the manager's reputation and the genuine attempt to avoid correlation.
With more retail investors looking at so-called hedge funds to diversify away from equity exposure, the chart below is a worry. It shows that just prior to the recent sell-off in the US, managers of long-short strategies (that is, 'long' some shares and 'short' others) had a record exposure to the S&P500 index of about 72%. In a rising market, they could not resist joining the party.
In Australia, long-short funds are becoming more common, and it's worth checking whether returns are uncorrelated to overall markets, as a fund which is 130% long and 30% short is still 100% exposed to shares.
Factfulness survey and the value of reading
Thanks to the thousands of you who participated in the Factfulness survey. Perhaps it was a timely reminder to step aside occasionally from the hustle of the week for brain battery recharging. Reading, especially out of your comfort zone, is a way to sharpen the mind. In one interview, Warren Buffett estimated that he spent 80% of his working day reading and thinking. Bill Gates told the New York Times that he read 50 books a year. Perhaps surprisingly, Australians on average spend an hour a day reading books, 70% of that is for pleasure. Two-thirds of frequent readers are female.
As guides for more reading, here’s the World Economic Forum’s list of the 20 most influential books in history, and Business Insider’s list of the 25 most influential books on business. Use our Have Your Say section if you want to add more titles.
This week, Leisa Bell summarises the results of the Factfulness survey. Overall, Cuffelinks readers did better than other Australians, but still only scored 37% from almost 5,000 participants.
Investing insights
Banks ... we love to hate them except when we collect healthy dividends. To give context to the Royal Commission, Ashley Owen shows the historical mistakes of the Big Four banks. The recent debacles are only the latest clumsy steps.
In a twist on sustainable investing, Stephane Andre and Bruce Smith make the case for actively selecting better companies with a positive impact, as against screening out the negatives. Back on the merits of indexes, John Peterson argues that the SPIVA scorecard for Australia is flawed.
Excessive product customisation can lead to an overload of choice and business failure, say Jessica Pallant and Sean Sands. They outline a middle way toward optimal customisation.
SMSFs have six key advantages as investment vehicles, says Graeme Colley, while Carlo Bongarzoni bemoans how changing legislation has adversely affected self-funded retirees and their SMSFs. It's another example of an individual personally taking his case directly to Chris Bowen.
Over 5,000 submissions have now been received for an intended Royal Commission into Aged Care Quality and Safety. This week’s White Paper from Challenger is a timely look on how to get the best out of aged care, including many specific examples.
Graham Hand, Managing Editor
For a PDF version of this week’s newsletter articles, click here.