I read The Little Book of Hedge Funds over a weekend. It’s an easy read and an excellent choice if you want to get a good overall understanding of hedge funds and the general industry of hedge fund management, selection, or absolute return strategies in general. It doesn’t get into detailed strategies, but instead a high level overview of the pursuit of asymmetric returns. My favorite part of the book was Anthony’s section on selection of hedge fund portfolio managers and how he defines “pedigree”. As he puts it (pp. 149-150):
“To make a long story short, the investment research and due diligence process is focused on determining or not a manager can: Generate attractive absolute and relative returns. Manage risk. Produce uncorrelated returns, with relatively attractive liquidity. Evolve as market conditions evolve. Perhaps most important, we have to understand how they will behave when the shit hits the fan in market debacles like LTCM, September 11th, the summer of 2002, 2008, the European financial crisis, and so on.”
He goes on to say he breaks the manager selection process into two categories. The first is Pedigree (pp. 150-151):
“Pedigree is an all-encompassing term we use to assess whether a manager possesses the right experience and skill to execute a particular strategy in a particular market environment. Typically, an investor should strive to find a manager with many years of real “buy-side experience,” that is, the manager should have actually managed a reasonable amount of capital over a reasonable period of time. The exception to this rule is a new, cutting-edge manager who is implementing strategies that may not have existed three years ago. You would be surprised at how many hedge funds fail the basic “experience” test. For instance, if a manager’s only prior experience is that he was a fixed-income salesman, you could undoubtedly find someone with more relevant experience and skills. For whatever reason, a lot of hedge fund investors tend to be drawn like moths to a flame to big-name sell-side guys who come out and launch a new hedge fund. A general rule of thumb: Avoid these guys like the plague as history has shown that they tend to always fail. After all, managing capital for private investors is completely different from running market making/prop trading outfits. Pedigree also includes a manager’s temperament and qualitative judgment. Is he a loose cannon or thoughtful and deliberative? Has he experienced personal and professional setbacks in his career and how has he responded? Has he treated his investor capital with prudence or has he viewed it as a tool to make a name for himself and get rich quick? Answering these questions takes a lot of work. But, if you want to invest with a hedge fund manager you have to be willing to roll up your sleeves and analyze that manager’s pedigree.”
I thought his explanation of pedigree is outstanding. He points out that pedigree is more about a persons actual experience and skill as evidenced by track record rather than the things we would see on a resume like college alumni, GPA, and places they’ve worked. It shows Anthony Scaramucci is the real deal. That is especially true because Anthony himself is a Harvard MBA graduate and began his career at Goldman Sachs before staring his own firm. Getting in and out of Harvard’s MBA program and landing a job at Goldman is an accomplishment, but says nothing about ability to manage money. A portfolio managers pedigree is about executing with an edge and is evidenced by a track record.
The Little Book of Hedge Funds description from Amazon:
- Explains why the future of hedge funds lies in their ability to provide greater transparency and access in order to attract investors currently put off because they do not understand how they work
- Shows that hedge funds have grown in both size and importance in the investment community and why individual investors need to be aware of their activities
- Demystifies hedge fund myths, by analyzing the infamous 2 and 20 performance fee and addressing claims that there is an increased risk in investing in hedge funds
- Explores a variety of financial instruments—including leverage, short selling and hedging—that hedge funds use to reduce risk, enhance returns, and minimize correlation with equity and bond markets
Written to provide novice investors, experienced financiers, and financial institutions with the tools and information needed to invest in hedge funds, this book is a must read for anyone with outstanding questions about this key part of the twenty-first century economy.