Tuesday, March 31, 2009

Media misses demand side of hedge fund equation

Think about what you read about hedge funds. What makes "news?" It's the AUM for the industry -- way up and now way down. It's the activists, the larger-than-life manager, the lavish hedge fund affairs. It's the flame outs, the frauds, the gates and the side pockets. It's the compensation. It's shorting and "black boxes."

All of this is the supply side of the industry. Nobody is writing about the demand side of the industry -- the source of those trillions in AUM and those willing to pay the notorious two and twenty for performance.  This lack of focus on the demand side is central to the the poor state of the reputation of the industry.  

The result is a situation in which the media criticize hedge funds without asking the simple question, "why do hedge funds exist?"  

They exist to serve the needs of their investors. Plain and simple. If they fail in what Dan Strachman in his new book calls the "hedge fund promise" (the ability to use all the arrows in Wall Street's quiver without taking on significantly more risk than the market as a whole to deliver alpha), hedge funds cease to exist. Everything about hedge funds is completely elastic. No performance, no assets. No assets, no hefty fees.

The people stretching (or not) that elastic are the investors, mostly large institutions. But hedge funds reporters are not talking to those people and, as a result, don't understand the demand for hedge funds and the ways good investors work with hedge funds on the key management issues like risk management, governance and reporting.

If I were advising a major fund or the MFA, I would work to have the fund's investors do much of the talking (to the media) for the fund. A company's customers are always the best evangelists and it is no different in the hedge fund industry. In fact, it's even more important in the hedge funds business because the demand side has received so little attention. Think about it. What's more credible to a reporter's ears? Having a hedge fund say that they allow investors free access to their books or having an investor tell the reporter that his auditors spend several days a year poring over the books with the hedge fund CFO and COO.

A recent profile of megafund Bridgewater Associates in Fortune takes steps in that direction. Here's an excerpt: "I view them [Bridgewater] more as a partner than a vendor," says John Lane, the director of Eastman Kodak's $7.5 billion pension portfolio, which has had money with the firm since the late 1980s. "We don't make a major change here in strategy without calling Bridgewater to get their view...Of all the investment firms we work with," he says, "they're the most trusted."

That is powerful. Any manager worth his or her salt, though, should be able to get similar endorsements from their clients.

The media and the public need to better understand why hedge funds exist. The answer comes from the demand side and the industry needs to figure out how to get those voices out there.

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