Picking the right hedge fund manager was probably never easy, but in recent years it has become an even greater challenge. Yet it is essential: You can invest in a winning strategy but still lose if the manager lacks the right expertise.
Top hedge fund managers do much better than the strategy average; their less skilled counterparts can do dramatically worse. Whether an investment in a given style is a brilliant success or painful failure depends on the choice of the fund and the individual or team managing it. An investor in global macro could have made 20% in the past 12 months--or lost 10%.
"This is a talent pool; not an asset class," says Robert Discolo, head of hedge fund strategies at AIG Global Investment Group, the asset management arm of the insurance and financial services company. "We can tell a good manager from a bad one early on, but it is very hard to tell the good from the great."
AIG was one of the earliest institutions to invest in hedge funds--in 1982. Now Discolo's group employs 25 analysts, who are divided into four groups in the United States covering long/short equity, event-driven, macro, and commodity trading adviser strategies. They also work as generalists in Europe and Asia.
They assess between 500 and 600 managers a year, first analyzing returns and volatility and then evaluating qualitative characteristics. It takes different skills to do this. It helps to be affiliated with a large financial organization and its global network. For instance, the team can use the AIG investigative unit to do detective work.
The group uses a multi-step method in making a selection; separate teams for research, due diligence and operations, and risk management must independently approve of a manager before the investment committee will even consider the fund.
Getting In Early
To discover talent more effectively, more institutions with long time horizons are running investment programs for early-stage funds. AIG Global Investment has a special program to invest in small hedge funds with potential, using the company's own money. "We noticed that the great managers in our current portfolio were those we got in with early, when the funds were small," Discolo points out.
These managers have to prove themselves within 18 months, or they're out of the program. If they do well, however, they get allocations from the regular portfolios. Some are now closed to new investment.
Discolo describes the AIG Global approach as similar to long-term investing in pharmaceutical research and development, where a pipeline delivers opportunities for the future. "It's good for us," he says. "We have been allocating money to managers for 25 years and we have to work now looking for talent for the next 25 years."--Jeff Joseph and Chidem Kurdas