From the September 2008 issue of Wealth Manager Web • Subscribe!

September 1, 2008

Building a Better Snapshot

More isn't always better, but when it comes to hedge fund databases, there's an argument in favor of using quantity to enhance quality.

The reasoning starts with the fact that no single database is comprehensive, says Meredith Jones, managing director at PerTrac Financial Solutions, a New York-based provider of investment management software for financial professionals. Of the 11 databases that can be imported into PerTrac's analytical platform, no one vendor even comes close to tracking the lion's share of the total hedge fund population, she reports. The next best thing is combining two or more databases in the quest to build a broader sampling of the hedge fund universe as a tool for developing superior quantitative intelligence.

There are more than 22,000 unique hedge funds in the 11 commercial databases that can be tapped through PerTrac, Jones tells Wealth Manager. The largest list carries less than half of that population. The good news is that multiple databases can be easily combined with PerTrac's software. The advantage comes at a price, of course, since each database requires a subscription, although there's no extra charge for analyzing databases via PerTrac. Even so, most PerTrac clients use only one vendor, Jones says.

Hedge fund databases aren't perfect, of course. They all suffer from various limitations such as survivorship bias, liquidation bias, backfill bias and so on. Part of the problem is that hedge fund performance reporting is voluntary, and so it's advisable to double-check the numbers and run a full due diligence review before committing money to managers.

Even so, with thousands of potential choices to consider, databases are valuable starting points for scanning the huge and ever-expanding world of hedge funds and narrowing the list. But as a recent conversation with Jones reminds us, not all starting points are created equal.

What is the benefit of looking at multiple hedge fund

databases versus just one?

At present, there's no single database that contains all of the information on all of the funds that are available for investment. If people look at one database, they're looking at a subset of the hedge fund universe.

How small of a subset?

We know from combining all of the available hedge fund databases that there are approximately 22,000-plus hedge funds available for investment. The largest database covers about 8,000 funds. So, if you look at one, you're missing out on at least 16,000 funds, one of which could be a better match for your risk-reward mandate.

Are there any surprises that come from looking at multiple databases?

Historically, the perception is that hedge funds are this or that--hedge funds are levered, hedge funds are risky, they move markets, they're billion-dollar portfolios, and so on. When you look at a better snapshot of the universe, you see that there are hedge funds that are small, that use no leverage, and that generally, there are hedge funds with a risk-reward profile for just about every investor appetite.

Also, having a broader database allows you to do a much better job of assessing whether you're in the right managers. Let's say that based on a relatively limited data set, you think a manager is pretty good. Once you put all the databases together and run peer-group analysis, you may find that there are funds that are much better suited to what you're looking for.

Funds of hedge funds are popular, in part because they offer diversification across multiple alternative strategies and managers. What's the population of distinct funds of hedge funds via the databases available through PerTrac?

Around 7,400 versus 15,250 single-manager funds.

How does the broad universe of funds of hedge funds differ?

You might have a strategy-specific fund of funds, such as one targeting arbitrage strategies. Others may be diversified funds of funds, while others might be low-risk funds of funds that target a lower return because of their mandate. There are also very aggressive funds of funds, while others are geographic-specific, such as an all-Asia fund of funds. There's a fund of funds for every appetite. That surprises people because they hear the term "fund of hedge funds" and they think of that as a strategy. But it's not a strategy--it's a vehicle. There's a lot of permutations of fund of funds.

How do the databases available through PerTrac compare?

All the databases provide monthly performance numbers as well as a subset of qualitative data. There are some common fields that you would see in any database, such as fund name, address, phone number, etc. As you get into more subjective qualitative information--like geographic breakdown and sector exposure--some databases carry more information than others. And different databases cover different funds. There are general databases that cover all strategies, all geographies. Meanwhile, specialty databases have been created in the last five years or so. These cover a specific geography or a specific strategy. For example, there's an Asia-specific database which includes only funds that are either located in or invest in Asia.

Why the differences?

Number one, hedge funds aren't required to report. Meanwhile, reporting to a database vendor is time consuming. You have to fill out an initial questionnaire, which can take anywhere from 30 minutes to an hour per fund, depending on how many data fields are collected. After that, you have to report performance each month. If you stop reporting, many database vendors will remove the fund, and so you have to be vigilant about reporting. But many smaller funds don't have a staff dedicated to those types of endeavors, and so they may report to only one database. Some may report to two or three vendors, but no one reports to all the databases.

How does PerTrac's database of databases work?

We don't have a master database that we resell. Rather, we give investors tools so that they can import [into PerTrac's software platform] as many databases as they like and create a master database for screening and peer-group analysis. If you put everything together, but don't remove duplicate funds, there are well over 50,000 funds. After removing the duplicates, the total drops to around 22,000.

How does someone access all the databases via PerTrac?

With PerTrac analytical platform's investment analysis and portfolio optimization tool. We have relationships with all of the data vendors, and so they all make their data available directly for download within PerTrac. A PerTrac client can access the databases he elects to subscribe to. You can add in traditional databases as well, such as a mutual fund database. By using our PerTrac ID function, you can identify and remove the duplicate funds. The last thing you want is a search that shows that three funds are really the same fund, which has slightly different naming conventions in different databases. You could figure it out yourself, but it takes time. The PerTrac ID function does the work for you.

What do prices start at for hedge fund databases?

There are databases that cost as little as $4,500 a year for a general data base, and that gets you 8,000-plus funds. If you look at the cost of a database versus how much it costs to collect equivalent data, the benefit is huge. In order to collect information on 8,000 funds, you'd probably need somewhere in the neighborhood of three to five full-time people. Plus, you'd need to develop a collection utility. As a result, the database cost seems almost ridiculously low. People tend to get wrapped up in the cost of the data without looking at the cost that a database displaces.

Do PerTrac's clients usually buy more than one database?

The majority get three or less, with the greatest number using one. There are people who supplement the data with their own proprietary collection efforts. Perhaps some clients don't understand the benefits of multiple databases.

Is buying a database directly from the vendor less expensive compared with purchasing it through PerTrac?

No. Either way, the price is the same.

What's the advantage of buying it through PerTrac?

If you bought two databases directly from two vendors, you don't have an analytics platform to look at the data. You have the raw data, but you don't have any way of massaging it to figure out which funds are the best choices. Also, once you put the two databases together, you wouldn't have an easy way of removing the duplicate funds. You might put two databases together with 12,000 funds between them, but 40 percent of the names might be duplicates. A lot of the vendors deliver the data in Excel, and in that case you need to program all the statistical formulas for evaluating the data. Even then, it's not easy to do peer group analysis. You can do basic statistics, but not much more than that.

I speak from experience. Previously, I was in the hedge fund world and was a PerTrac client. We did everything in Excel and Access, and it was a laborious process. For higher level stats and functionality, Excel is not where you want to live. PerTrac calculates over 900 statistics and removes the duplicate funds.

Doesn't Morningstar have a fairly advanced hedge fund database and analytics package?

Morningstar does, but not all of the vendors are affiliated with software products. Hedge Fund Research, for example, doesn't have a software package. Morningstar is the exception rather than the rule. Also, some of the vendors have online functionality, but if it's online, you can't combine the databases because the data is available only through the online platform.

What are the risks associated with databases?

It would be nice if the data was enough, but it's not. There are all kinds of issues that one must cover in the due diligence process that don't have a lot to do with the quantitative side. For example: What kind of valuation policies does the fund use? What's the manager's experience? What's the hedge fund's operational risk? You can't simply say, "This fund has good monthly performance; I'll take that one." The data is really a starting point. After that, you have to do the legwork and go through a full quantitative and qualitative review.

But you need a tool for screening and narrowing the list of funds. Otherwise, reviewing a huge group of funds is impractical, and it would probably drive you insane.

James Picerno (jpicerno@highlinemedia.com) is senior writer at Wealth Manager.

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