TL;DR Seth stubbed his toe, Hedge Funds 101, private capital is the t!ts, hug your advisor
Slow morning so I put some further thought into this. I enjoy sharing what I've learned and listening to differing points of view. There is a time and a place for hedge funds, and there is a time and a place for private capital for suitable investors. It doesn't make one an undesirable or less sophisticated if neither are their cup of tea. But a strong case can be made for both when used properly and in moderation.
First, Baupost Group/Seth KlarmanI've been familiar with Baupost for some time now, but don't have any money invested with them. There's not a great deal of public information on Baupost, but I did find this to share to support my commentary below:
Music ends for Oracle of Boston (I authored this title - don't hate the player)
I'm not really that smart, but at a recent hedge fund conference I had the opportunity to listen to and speak with many of the industry's major players such as Jonathan Grey, Larry Fink and David Rubenstein along with countless insiders. From that, word is Baupost got pummeled in 4Q on Equity correction (duh) and a particularly large position in PG&E. For 2018 they are expected to report the worst annual return since Seth's inception in 2008 (almost certainly negative) depending upon how aggressively they mark-to-market their subrogation claims related to the PG&E position. What is known is that PG&E assets, including all its reinsurance protection, will come nowhere near the potential liabilities. Thus, the value of those claims, admittedly bought at a steep discount to hedge the equity position, are expected to continue to fall as the bankruptcy takes shape. My educated guess is that you will likely see some degree of underperformance in 2019, which, arguably, they are due. In 2017 they were returning money to investors, which is not uncommon for a $30B hedge fund's opportunity set, but likely will be waiting with open arms for more money by next year. So, I'm saying there's a chance
(that they reopen to new investors like AgBank).
Second, Hedge FundsThe thing is, Hedge Funds (like Baupost) are not Private Capital; they're completely different animals. Further, the hedge fund space is quite large and diverse. Just as you see sector rotation in equity leadership through economic cycles, the same is true of hedge fund strategies (Relative Value, Credit, Macro and Equity are the 4 broad categories). Presently, there are some 15-20 identifiable hedge fund strategies depending upon with whom you talk. Of those, there are probably 3 or 4 that you want to be in today or soon. But since they all are private placements which requires time for investors to position capital, one must anticipate the sweet spot and that determines success far greater than whether you have a top decile vs second quartile manager in your lineup. For those reasons, most investors, particularly recently anointed Accredited Investors ("AIs") and Qualified Purchasers ("QPs"), choose to stick a toe in the water with a Fund of Funds ("FOFs") manager who gets paid to make those decisions and allocate capital across the spectrum. The one I always start investors with, which is available to AIs, returned almost 4% net in 2018 and likely will generate a double digit return in 2019. What you give up with FOFs is the homerun ball like Baupost swings for, but what you gain is a high batting average in a turnkey solution. If you work with an advisor at a major firm, you should have this FOFs available to you on their platform. Just ask him/her for Series G and they should know.
Third, The Sophisticated Investor & Private Capital's roleThe evolution of a sophisticated investor, in my opinion, typically follows this stage pattern:
- Public Securities (stocks, bonds, mutual funds, REITs, MLPs, etc.) = anyone can do this
- Private Situations (usually seek higher returns than public securities markets: business co-investment, angels, direct loans, sole or consortium real estate) = anyone with extra cash flow/savings and an appetite for idiosyncratic risk
- Initial Public Offerings ("IPOs") = only available to "good customers" of syndicate firms
- Hedge Fund of Funds = (usually have bad experience at stage 2, seek to reduce risk through greater diversification and opportunity to participate in inefficient markets) AIs $1M+ liquid
- Single Strategy Hedge Funds = (usually surrendered stage 2 investing but not mutually exclusive, seek to raise performance of a diversified portfolio) sometimes AIs, usually QPs $5M+ liquid
- Private Capital = (usually committed in tranches and always to equity, sometimes credit and real estate and seek to improve total portfolio return) always QPs $5M+ liquid
- Pre-IPOs = (investing throughout the capital structure alongside investment banks, desire for outsized gains) always Super-QPs $25M+ liquid
- Family Office = (seek to take majority or full control of investment policy and due diligence but generally at greater expense) Multi-generational wealth generally $250M+ minimum
Allocating to private capital takes 5-7 years to do it correctly. Just like wine, some vintages are better than others. Allocate a portion each year over time. For example, if you allocate a new position now you likely are buying near-high valuations. However, in the next two years you may be buying near-low valuations. Using a little common sense, there are algorithmic programs to aid an investor in making capital commitments over time to match capital calls with anticipated distributions to achieve the target portfolio allocation. However, generally speaking, the returns are consistently greater than public markets over any reasonable rolling time period and usually by a wide margin.
Here's an article on the topic from last week by Dr. Richard Marston, professor of finance, Wharton School at the University of Pennsylvania:
How to cope in a world of lower returnsI'll conclude by acknowledging that I don't have all the answers and I don't pretend to be the smartest guy in the room. I'm constantly learning and re-learning and understanding investor psyche and handling objections is central to my role. There is no "one size fits all." As financial markets and financial services evolve, so, too must we. I've spent this entire post talking about investing, but really that is just about 1/2 the job of a Private Wealth Advisor who serves the affluent. Perhaps that's why I am easily annoyed by those who would shame the financial advisor's role or desire to be compensated for professional services. To that crowd I offer, you probably don't need an advisor because you likely have little to no complexity. You probably don't need an attorney or a CPA either. But that doesn't mean that you never will. As wealth grows, complexity multiplies at a rapid pace. There are plenty of people who eagerly pay to have a quality advisor in their corner.
**This is neither an investment recommendation nor financial advice. The comments are educational in nature and the sole opinion of the anonymous - if not entirely suspect - poster and not that of any past, present or future employers. This is not a solicitation for advisory services.**