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The Future of Hedge Funds

Oct 7, 2021

Hedge fund assets have soared to record highs. A new economic environment, categorized by volatility, the success of industries that have provided critical goods and services over the past year and a half and sky high stock prices, has reinvigorated the industry and created new opportunities for hedge funds with traditional and new strategies. How managers move forward to take advantage of these opportunities will define the future of the asset class.


Katie Brandtjen:

Thank you for the introduction, Steve and Irina, and thank you to Alan, Paul, Scott, and Simon for joining me on our panel today. Let's jump right into our first question.

Many investors are placing an increasing priority on environmental, social and governance considerations. To what extent are ESG considerations becoming part of the manager research, due diligence, and selection process? Scott, I'll turn it over to you first.

Scott Radke: We're really seeing ESG get incorporated in the hedge fund community in two ways. The first is more defensive from a risk identification perspective, and the second is a more offensive implementation, which is constructing portfolios, which are specifically designed to have an impact orientation. On the defensive side, this is really fundamental credit and equity managers considering the earnings or balance sheet implications that environmental or social event could have, and of course, governance has always been a consideration, especially around minority rights and hedge funds have often been vocal advocates in enforcing those rights.

We also see governance signals show up in quant equity manager programs as one of their signals. So I think there's a pretty long history of considering those as part of the investment process, but again, more related to identification of risk. I think the more recent shift is in response to the demand from allocators to have investment portfolios that are oriented, not just towards risk and return, but adding this third dimension of impact. Which is pretty fundamental, if we think about the shift that that implies towards the optimization and portfolio construction process, and as a result, we've seen both on the long, only side, as well as the hedge fund side, quite a few new products being launched, and at least from our seat of pretty big dispersion in terms of the quality of those, some really do represent a fundamental reorientation of the portfolio construction process and a real impact delivery. I think others probably deserve the label of groom washing.
Katie Brandtjen: Thank you, Scott. Paul, can you share your perspective on how ESG priorities are impacting fund managers in their processes?
Paul Glazer:We are seeing regularly now, and this change has really just happened over the past two years, that basically everybody's not everybody, but majority of people who are doing due diligence on Glazer capital are now looking at our ESG policies. I am not yet at the point where I think that it actually impacts to a large degree, their allocation decisions. I think that it's more at this point, it is quickly evolving as we all know, and at this point it's more of a, kind of a check the box. Do you have an ESG policy, please send us your ESG policy. So we do think it's important. It is something that personally, I want to see promoted. It's hard to be against any of these policies and it has to carry over into the investment side, what we're doing.

I found that the best description of why it's important to have an ESG policy came from one of our family office investors. They said, gee, you know, we, I'm speaking to the investment people at this family office. They said the family has a lot of money. They they're very philanthropic and they're giving money away or ESG causes. Why would they invest in companies that are going counter to what their philanthropic goals are going toward? So that made a lot of sense to me.
Katie Brandtjen: Simon, from your vantage point, what trends are you seeing when it comes to family offices and institutional investors you work with in this area?
Simon Fludgate:Yeah, I think ESG has certainly come on in, I would say the last five years, especially even in the last two years, it seems like there's been a cataclysmic shift in how much people care about ESG or ask questions or and it comes from our institutions asking us, and then we obviously have to have a policy of our own and also look towards where they're investing and what the policies are there.

There's two, I think there's a lot, one of the issues with ESG is it can really encompass quite a lot. And I think a lot of people look at it and they expect different answers or want different things from their policies. Really, I think when it comes down to it, there's two major issues. I think that people are concerned about these days that we work with managers to try and kind of quantify if possible. One is, and this is more center to the U.S., you know, a little bit in Europe, outside of Europe and the U.S. really, not that important, but diversity.

So diversity of staff, diversity of the management team, that kind of thing. So we do get a lot of questions on that. We do collect the data on that from our managers to trying kind of at least get the information to our investors, as I think Paul mentioned, you know, they, it's not quite clear if people are actually making decisions based on this, but I think they're still in the process of kind of collecting this data.

The second is a lot more difficult, especially in the hedge fund space is really carbon footprint. So what is the carbon footprint of the actual firm itself? And then what about its investments? How do you measure carbon footprint? That is a little more challenging. It's easier when you get into kind of like, or slightly easier when you get into private equity kind in a portfolio, but in hedge funds, it can be extremely challenging to gather that information. And I think the information, even when people do provide it, is provided in a different kind of format. So it is challenging, but I think that's where the industry is going. It’s really these two kind of fundamental pillars or what people are really looking towards measuring in their portfolios, and we're getting there. It's just taking a while to get there.
Katie Brandtjen: That's a great perspective. Thank you, Simon. Alan, I'm going to let you chime in here. What kind of significance are you seeing placed on ESG considerations in your work with family offices?
Alan Reid:Oh, thanks. First of all, just say, if you met one family office, you've met one, just one family office. You know, it's probably over repeated, but it just, it makes the point is that some families, this is a critical area of concern. I remember count counseling a Gen 3 three member who wanted to give all her money away and was like horrified when she found out that she had, hundreds of millions of dollar net worth, and yet others, this is not, this is not a priority. I am a little jaded. I ran a couple, we ran a couple million dollars for the Sierra club for six years. And I walked away really wondering, a lot about what I've already heard. What is true impact, what is green washing, and how are you actually going to change things? And I think that, frankly, I'd been asked by a nonprofit to help in 2017.We worked together with a couple of found family foundations and organized an effort. I encouraged them to focus on basically a hedge fund strategy, an activist strategy, rather than their normal sixties activist work. We targeted a company named Exxon, some of you may be familiar. We ended up getting six environmentally minded folks on the board of Exxon in the last year. Just keep in mind, I don't believe one ESG fund participated in what was probably the largest environmental coup.

So at least not on the mutual fund side, perhaps on the hedge fund side. So, I think that in looking at it and I guess one did, a couple of you got D.E. Shaw and engine one both were leaders in that space, but to that same point, environmental, social, governance, what they left on the table was governance and ignored a shareholder move to independent chair.

So ESG is very much in the eye of the beholder. I think that, one of the challenges is that very few people share the those same similar values on all fronts. So I think going back to the green washing comment, I would just say that one has to be careful that they're not getting a teddy bear and just feeling good about something and actually having true impact. You see that in private equity, in the private venture Space, it's much easier to have impact. Otherwise, if you're not a shareholder, you don't have a vote. It's very hard to have an impact there too. I think that there's a lot of room for improvement, and I think that different families are approaching this in a different way, but a friend of mine's family foundation just hired a consultant. I think they're just announcing it yesterday or today, but the focus at $500 a million New York foundation focus on purpose and not on returns. So certainly, there's a change of foot.
Katie Brandtjen: Thank you all. It seems safe to say that the importance of ESG considerations is unlikely to wane anytime soon, but it is a complex and evolving area, and navigating the space, leading in this area may provide opportunities for real impact. Let's move on to our next question. Scott, based on what you're seeing in the marketplace, what types of strategies do you see the industry moving toward?
Scott Radke:I think one of the biggest trends is around a private investment by hedge funds that historically have just looked at public equities and you're seeing the convergence between the PE side. In the sense that earlier investments in pre IPO candidates, ahead of some sort of liquidity event, and I think obviously this isn't brand new, we saw hedge funds dip their toe in a reasonably big way into illiquid assets prior to 2008 and then saw a big pullback from that. So I think to some extent there's some cyclicality to this. The other thing which is a little bit more micro, is we're seeing more opportunities to participate in the equity market, equity capital markets calendar. So, IPOs, blocks, secondaries on a dedicated basis. Again, this isn't new. This has been a strategy that's been bundled up in multi-strats and a profitable one at that.

But over the last couple of years, we've seen a much greater ability to invest in that on a standalone basis. I think is really taking advantage of the robust environment in the capital markets. The last comment I make is not a strategy particularly, but a region and it's Asia, while there was a brief pause after March 2020, in terms of interest in Asia, we see really broad and widespread action in terms of trying to diligence managers in the region and identify ways to participate as the long only side is starting to build up in that area. I think the allocators are looking to see how they should be approaching the region from an absolute return perspective. You're seeing quite a bit of research there, certainly disproportionate to the capital that's allocated.
Katie Brandtjen: Very interesting, thank you Scott. Paul, what are thoughts on strategies that will be successful moving forward?
Paul Glazer:We participate in merger arbitrage. We've been doing it for 22 years, and I started in it before that. At that time it was an old strategy, it was always a niche. It's kind of a staple. It's not ever the flavor du jour. What has come into, crept into the strategy, broadly speaking is SPAC investing. We've been investing in SPACs since 2009. We started back then, because during the great financial crisis SPACs went to discounts to cash and trust. So we said, this is easy, we'll just buy them at discounts to cash trust and wait for them to go up in which we did. We've done that every year since then. It's always been a small part of what we do, it was never ever something we heard about from brokers or other ARBs and the long and behold, late 2019 and into 2020, it became a hot area.

I think due to COVID people were at home, they were bored and they just started buying specs anytime they announced a deal and it was good for us. We were, up 33%, 37% in 2020, which is far beyond anything we ever had before. That seems to be over right now. But what has remained from that is that there are now 400 SPACs outstanding is opposed to maybe 40 or 50 before this all started in late 2019, and SPACs have become legitimate. It used to be that only marginal companies that could not do traditional IPOs would find another way to go public. They would do it through a SPAC because they don't have all of the reporting limitations that an IPO has and can put out projections, have become a very important way for companies to go public.

So I think that's going to be with us, that's a permanent change, and that's going to be with us going forward as a place to invest that it's not particular relevant to us. We only invest more from an arbitrage point of view that we have started to Scott's point, two other funds that invest in the illiquid part of SPAC capital structures. Those are, were investing in the risk capital and in pipes. We found a pretty interested audience and raised a decent amount of money in that area over the past year. I think, that is also is going to continue.

That also is quickly evolving as valuations get worked out for what are oftentimes non-profitable companies and sometimes late venture type of companies, that are now in the public marketplace, that had never had been previously. So that will be good for our non-public illiquid funds that we raise, which is a small part of Glazer capital in general, and will really have a big impact or any impact on the big funds that we do manage. But I do see that continuing people do have an appetite for the privates. That's what I see. Thanks, Katie.
Katie Brandtjen: Thank you, Paul. Thanks for your thoughts on where we are in the SPACs cycle in particular – Alan, what asset classes or strategies do you see on the upswing?
Alan Reid:Well, first of all, I did want to just mention that I, a big believer in the liquidity features on mutual funds. And I think that will continue to be a challenge. In '08, a family I was working with had a lot of challenges with liquidity. So having liquidity is really the one factor that allows for low correlation to be a benefit. That said, speaking of low correlation, things like crypto, I think that we're going to continue to see growth in that area, more sophistication, not too different than what we've already seen in cannabis, as that continues to grow in the space. Families continue to be very focused on fees and they hate paying fees. I mean, that's what I kind of am tired of.

It's like, don't, you care about the ultimate return, but people care about fees and they want to feel like they're getting something for their fees. So typically families are much more interested in co-investment opportunities, opportunities where they feel like they can add some value. And then there's a lot of families that are working together, especially here on the west coast, where they believe that they bring the alpha themselves and that Wall Street doesn't have any alpha to offer. They can be quite outspoken about that.

But I think you see that with many of the first gen entrepreneurs, where they are teaming together to make investment direct investments themselves. That said, the comment I hear from them regularly is that we're really good at alpha but the challenge is, we don't know how to manage our cash. And so strategies like Paul was talking about where there's a deep understanding of different strategies that in analyzing the market, I think that there's a big interest, will always be a continued interest there. And as interest rates, short term interest rates are, you know, are zero, people will continue to look for how do we manage or save money? How do we get some return versus what we get at the bank.
Katie Brandtjen: Thank you, Alan. Now I'd like to pivot to the operational side of things. Working from home has reshaped how businesses conducted their operations during the last year and a half. And we know hedge fund operations did not escape this disruption. How do you think what we've learned in the last year and a half has shaped the future of hedge funds with regards to core processes in the working environment? Let's start with you Simon.
Simon Fludgate: Yeah. I would say disruption could be called transformation here, because it has really transformed quite a lot of how we are seeing people operate. I think the most obvious is a good example here, right? We're not all in person we're actually zooming over a virtual network, right. That seems to be transitional in that, I think a lot of people never thought that this would exist and never thought that it could work in the past and people have really come to believe that we can work over kind of remotely. It's not optimal. I will say my personal feeling on this is the longer we are going into this cycle, the harder is to actually build a culture and get and train analysts and get them up to enjoying working at someplace, not just for the salary.

I think that's always a challenge. I mean, they have called this. There is a lot of turnover as everybody knows, the great resignation as they call it. But, I think part of that is going to continue as long as we are all going, as long as most people are virtual. I think it also transitioned, a lot more went to the cloud. That was happening anyway, but I think a lot more of our kind of the funds that we look at, actually all the managers we look at actually went to the cloud. One kind of legacy thing that's definitely going away is the use of kind of an offsite for if your office was unavailable everybody meet up in Stanford, Connecticut in 50 desks up there that I keep as a hot site, that I think has been quickly going away, if not put to grave.

I think people realize it's much easier for people to work in their office or from the home than they thought was possible. So I think all of that has really changed from where it was. I do think going forward most people are going back to an office environment. I know we've got a selection of people in already and that's growing pretty much every week and hopefully will be back. But I do think people will be giving more flexibility. And I think there's two parts to that. I think one is people have realized it works. And secondly, I think the employees are kind of in some, especially some sectors are kind of using that and looking at two different employment opportunities and saying, if I can work two days from home in this, it's actually more attractive to me. So I do believe that we are going to go to some kind of a hybrid model, most likely for the going forward.
Katie Brandtjen: Thank you, Simon. I really like your comment, disruption can be viewed as transformation. Alan, what changes do you expect the industry to adopt going forward when it comes to how work is conducted and are there norms you think the industry is eager to return to?
Alan Reid:Interesting. You know, I think from a family office perspective the big challenge really is going to be back to the same thing about family offices. Each of them is different. I think that generally people are going to be much more willing to accept remote work. But I think that family offices by I think their nature are very demanding and I would make sure I would encourage people to make sure they're not overly optimistic about their ability to not travel. We just had, I'm doing an annual conference in the Hamptons in August. We had 150 basically billionaire families only, we had 150 people show up in between the hurricane cycle. We were all outdoors and hurricane no hurricane, these families showed up because they wanted to be in person. They did the same thing last year.

There's a big benefit and people understand the value of in person meetings. And so while I think that there'll be far more opportunities to serve clients remotely and by zoom, there are also will be a lack of patience for folks that aren't willing to show up in person for meaningful relationships.
Katie Brandtjen: That's a great point. Thank you, Alan. Paul, what ways do you expect the working environment of the past year and a half to affect the future of work in the fund space?
Paul Glazer:Well, just looking around my office, we had 25 people in here yesterday and four today. That sums it up in a nutshell, it's going to be hard to get people back into the office five days a week. I don't think that's realistic anymore going forward.
I think the transition that we went through because of this disruption was very successful for everybody. I mean, everybody says the same thing, including us, that was, I would never have chosen to do that, but now that we've done it, it was a lot easier and a lot more productive than I thought it would be. So I don't see us going back.

The longer term repercussions I think are going to be serious. And I don't think they're known. I mean, training people, creating culture, creating personal happiness. As Simon mentioned, what is there to a job. And you know, now we have a record number of people unemployed and a record number of people looking, a number of jobs going begging standards of change. And I think that they will continue to change in ways that are not going to be easy for us to predict. But I think to bring it down to practicality and the hedge fund land, I think due diligence will be easier where I don't think we're going to see nearly a number of people coming through our office that we have seen in past years.

I think people have taken to zoom and I think it's actually pretty effective. As far as the personal relationships, I question how important that is, but then we have an investor base that knows us and it may be more difficult to acquire new investors in the future because that we are lacking that personal introduction in the personal relationship. But I wonder if that in general will become less important. I don't know if numbers will speak more for themselves. 
Katie Brandtjen: Thanks Paul, and while there've been serious disruptions in the past year and a half, the fund space has also been pretty well positioned to adapt and transform, and you've all spoken to this meaningfully. So before we conclude, are there any final thoughts related to the future of the industry that you'd like to share with us? Scott, I'll turn to you first.
Scott Radke:One of the biggest challenges facing allocators has to be the view that the returns from traditional equity and credit markets are likely to be a lot lower going forward than they have been over the last decade or so. And I think the challenge for the hedge fund absolute return community is to identify what role we can play in trying to help solve the portfolio conundrum that that conclusion creates. And, I think in a way it could be the biggest opportunity since going back two decades.

You saw institutional capital begin to flow in to hedge funds, and you can think of two examples of, for example, imagine a low beta liquid portfolio of hedge funds serving as a partial substitute for a fixed income portfolio, or maybe a slightly higher beta, maybe a bit less liquid, higher octane portfolio, taking a little bit of capital away from equities. It's not clearly displacing massive percentages of either of those allocations, but I do think there's an opportunity for hedge funds to play a much more meaningful role going forward in terms of helping allocators, be it pension funds, sovereign wealth, family offices, achieve their return goals in the future in a more sustainable, robust way than just a more concentrated allocation to equity risk.
Katie Brandtjen: Thank you, Scott. Simon, any final thoughts you'd like to share?
Simon Fludgate: Sure. I'll touch on two points actually. The first is kind of going back a few questions ago, just really, we heard talk, people talk about kind of Scott talked about privates and how a lot of hedge funds are kind of getting into kind of late stage IPO or pre IPOs. We've also talked about a little bit about, Alan talked a little bit about liquidity. I will say, one of the things that we are very cautious about and tends to go in cycles, unfortunately is just asset liability mismatch.

So just we are getting, you think you can get out and you really can't right. Or when you want to get out is when things have turned bad and you are effectively stuck in a manager for a long time in a typically in a terrible situation. So I'd just be cautious about paying attention to that I think is very important. The second, this is more of an operational issue, which is just cybersecurity, I think is it continues to be of utmost important. We talked about the transformation just even signing stuff oftentimes it's done electronically now and things are sent electronically and just everything. Everybody still needs to pay a lot of attention to` cybersecurity. It's not just ransomware. It's a lot of different ways. It can come back to bite you.
Katie Brandtjen: Great thoughts. Thank you, Simon. Alan, you want to close us out?
Alan Reid:Well, I can't help, but to jump on that lead liquidity clearly is going to be an issue and we've had markets have been straight up. There's been low volatility for years now, and looking at it, what we know is those things do revert to a mean, and I would just say that in looking at it, hedge funds have a great opportunity here where I do believe active management is going to start showing its benefits. From a leadership perspective,

We've seen it in the ESG Space already, as I mentioned with de Shaw and engine one and others. But I think the sixties activists have finally figured out that wall street knows something and that is how to engage with companies. So I do believe there's a great opportunity for hedge funds to provide more leadership with regard to corporate actions, engagement with companies. It's certainly not something that we see from the large institutional investors. They don't have the expertise. They definitely have an interest as we've seen sort of this whole CA 100 rise and claims of, you know, 20 to 40 trillion dollars being managed with an ESG bent. Hedge funds are truly the leaders with engaging with public companies. So I think that there'll be more and more opportunities utilizing proxy actions.
Katie Brandtjen: Thank you all for joining me on our hedge fund panel and sharing your thoughts and insights with us today.

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A New Era for Private Equity and Venture Capital

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