January 04, 2013

In an interview with Advanced Trading, hedge fund consultant Richard Wilson breaks down whether the outsized returns that made the industry popular are now a thing of the past following another underwhelming year.

Advanced Trading: What do the lackluster returns we saw from hedge funds in 2012 mean for the sector this year? Can we expect more of the same?

Richard Wilson: I think that hedge fund portfolio managers have been protecting their downside and that is a healthy stance for the industry.

It is most important that assets of clients are not lost, for the industry, and for individual funds in terms of retaining the respect of investors. Many people criticized hedge funds for losing money in 2008, even though they lost less than the general marketplace. The message was clear, "You should have lost even less."  

Yet now, the general public has criticized hedge funds for not gaining more in 2012. What's important to note in all of this is that the "smartest" money, from institutions and institutional consultants has been investing a higher percentage in hedge funds now than ever before.  Through all the turmoil, institutions globally are turning to hedge funds more than they did before 2008. That says something important about returns.

Advanced Trading: Are the outsized returns that made this industry popular now a thing of the past?

Wilson: I don't think so. I believe you have to look at hedge funds by strategy when you talk about expected returns and inherent risks.  A small cap long/short hedge fund has a different risk profile than a global/macro manager, or a MLP hedge fund portfolio.  As the industry becomes more institutionalized it will be more about the steady returns rather than big swings however, so that trend is not going to go away even though it may seem to at times because the media loves to focus on the people who blow up or knock it out of the park for obvious reasons.

Advanced Trading: So are hedge funds now more apt to focus on protecting steady – albeit mediocre – gains rather than aiming for huge returns? Is this a product of so many hedge funds now catering to institutional investors?

Wilson: There are so many hedge funds in the industry now it is hard to categorize them as being risky or not. All different levels of risk are available, even from the same hedge fund manager in many cases. There are managers out there always swinging for the fences, and others who have strategies literally called "Capital Preservation Portfolio Series," etc.  

The industry is diverse. That said, there are more large hedge funds who are taking core defensive positions, focusing more on what institutions want in terms of being risk averse and trying to return solid 7-12 percent returns instead of 13-20 percent-type returns. Many investors look at 15 percent returns as an obvious sign of outsized risk taking by the portfolio manager, whether or not that is true for every type of strategy. 

ABOUT THE AUTHOR
As the Senior Editor of Advanced Trading, Justin Grant plays a key role in steering the magazine's coverage of the latest issues affecting the buy-side trading community. Since joining Advanced ...