Hedge Funds: Fee Compression, Active Management, and Low-Net Exposure

Trends Watch

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.

This week, Elana talks with Greg Royce, Founder & CIO, Maximus Long Short Equity Management, LP.

What is your outlook for alternative investments?

There are many “alternative investments,” but I’m going to talk about the category I know best: hedge funds.

As we all know, the data has not been supportive of the fees charged. Additionally, the lack of actual hedging and risk management at many firms has been disappointing. So, the trend in fee compression will continue and deservedly so. However, this doesn’t make the category obsolete, especially for talented managers who can perform well. Additionally, with the QE cycle ending globally and the Federal Reserve (the Fed) reducing the size of its balance sheet ($370 billion in 2018 alone), this has created increased volatility which passive management, heretofore a winning strategy, is going to give way to active management.

In my opinion, the timing for low-net exposure strategies is ideal. Shorts are working very well and there is most certainly alpha to be had in company-specific situations, of which there are many. In addressing the above-mentioned commentary, new funds need to be creative with fee structures to attract investors and to gain the trust that people would have hoped to have received over the last five-ten years.

What is your outlook for the economy?

The data is showing signs of an economic slow-down, but not a recession. To quote a recent set of commentary by Michael Darda, chief economist and market strategist at MKM Partners, in Barron’s: “few of the signs that usually presage a recession are evident.” Rather, the yield curve is flattening, but hasn’t inverted and money supply growth is still growing. Even to the extent the yield curve has inverted in a few year-to-year segments, it is not material as minor temporary yield curve inversions have not typically presaged recessions. Additionally, as a recent article in The Wall Street Journal pointed out, consumer spending remains healthy, U.S. average hourly earnings rose 2.9% in 3Q18 and November was a strong month for industrial production. Thus, my outlook for the economy is that the sky is not falling, but we need to be “data dependent” as we have heard the Fed say many times. On this topic of the Fed, given economists are now more concerned about GDP growth slowing to less than 2.0% in 2H19, I expect a less dramatic rise of the federal funds rate.

What keeps you up at night?

There are many issues to be concerned with in this increasingly linked global economy: trade wars, politics, Brexit (and other similar situations), withdrawal of QE by central banks, increasing stress in the high-yield markets (partially as a result of the drop in the price of crude over the recent months), etc. All of this has led to increased volatility. Nevertheless, earnings are up this year while the market is not leading to more attractive valuations. Thus, keeping tight net exposures, but not being scared to deploy capital into interesting situations, is the way to invest in this late-cycle, increasingly volatile market in my opinion.