Managing Hedge Fund Managers

Invaluable insight into measuring the performance of today's hedge fund manager

More and more institutional funds and high-net-worth assets are finding their way to hedge funds. This book provides the quantitative and qualitative measures and analysis that investment managers, investment advisors, and fund of fund managers need to allocate and monitor their client's assets properly. It addresses important topics such as Modern Portfolio Theory (MPT) and Post Modern Portfolio Theory (PMPT), choosing managers, watching performance, and researching alternate asset classes. Author Edward Stavetski also includes an appendix showing detailed case studies of hedge funds, and gives readers a road map to monitor their investments.

Edward J. Stavetski (Wayne, PA) is Director of Investment Oversight for Wilmington Family Office, serving ultra high-net-worth families in strategic asset allocation, traditional and alternative investment manager selection, and oversight. Preface.

Highlights of the Book.

Acknowledgments.

Introduction.

The Art and Science of Hedge Fund Investing—Are You Precisely Wrong or Approximately Correct?

The Explosion of Hedge Funds.

What are Hedge Funds?

Finding a Comfort Zone.

A Look beneath the (Book) Covers.

As You Begin.

Chapter 1. Asset Allocation and Fiduciary Duty.

Investment Policy Statement: The Roadmap.

Determinants of Portfolio Performance.

Why Alternate Investments?

A Closer Look at Hedge Fund Structures.

The Rise of Socially Responsible Investing.

Fiduciary Responsibility.

Where Do I Start?

Chapter 2. Large Versus Small Funds.

Good Things in Small Packages.

Research Confirms Small Fund Advantage.

Performance of New Small Funds.

Attrition Rates.

Drivers of Outperformance.

Invested Interests.

Aligned Interests.

Point of Diminishing Returns.

Master of Trend line Analysis.

Chapter 3. The Search for an Honest Man.

Finding Your Manager.

Prime Brokers.

Conferences and Industry Events.

Industry Publications.

Incubators and Platforms.

Industry Websites and Databases.

Building Your Own Database.

Unconventional Sources.

Six Steps to Kevin Bacon.

Sizing up the Flock.

What's in the DDQ?

Summary.

Chapter 4. Performance Analysis.

Torturing the Numbers Until They Confess.

The First Step: Understand What Is Being Measured.

Two Sides to Hedge Fund Performance: Long and Short.

Performance Standards.

Check the Entry

Finding a Benchmark

Peer Analysis

Confusion from the Best and the Brightest?

A Practitioners View.

Examine the Bad.

Examine the Good.

Expect the Improbable.

I Surrender.

Chapter 5. Risk in Hedge Funds.

Risk Is Like the Weather: Everyone Talks About It, but No One Does Anything About It.

Major Risk Categories.

Liquidity Risk.

High Watermark Risk.

Concentration Risk.

Operational Risk.

Liquidity Mismatch Risk.

Transparency Risk.

Risk Process.

Leverage Risk.

Short Selling Risk.

Reputation Risk.

Submerged Risk.

Counterparty Risk.

Market Risk.

Credit Risk.

Model Risk.

Complexity Risk.

Key Person Risk.

Sensitivity to Assumptions Risk.

NAV Instability Risk.

Derivatives Risk.

Summary.

Chapter 6. You Only Find out Who Is Swimming Naked When the Tide Goes Out.

Look Behind the Numbers.

Filling out the DDQ.

Form ADV Part II.

Fund Brochures and Documents.

Planning the On-Site Visit.

Summary.

Chapter 7. Let the Games Begin.

The Due Diligence Process.

The Process.

Examining the Organization.

Preparing for the On-Site Visit.

Preparing the Final Evaluation.

In Conclusion.

Chapter 8. Getting Ready is the Secret to Success.

Portfolio Construction.

Top-Down Strategy Analysis.

Bottom-up Manager Analysis.

Test or Model the Portfolio.

Portfolio Optimization.

Summary.

Chapter 9. Navigating Buyers Remorse.

It's Always Darkest Before It Goes Completely Black.

Long Term Capital Management: Poor Diversification and High Leverage Are a Dangerous Combination.

Bayou Group, LLC: Due Diligence is a Must.

Wood River Capital Management: A Lack of Experience and Auditing.

MotherRock: The Liquidity Squeeze in a Small Market Will End Badly When Volatility Increases.

Amaranth: Liquidity and Concentrated Portfolios Can Drag a Fund down as Trend of Any Trade Eventually Reverses.

Recent Events: Ospraie Fund.

Your Final Exam.

Applying Your Education.

The Importance of Second Acts.

Chapter 10. Monitoring Your Flock.

I Walk in the Valley Darkness, I Fear No Evil.

Everyone's Favorite Metric: Performance.

Portfolio Exposures.

Performance Trends.

Peer Group Analysis.

Strategy Reviews.

Fund Size and Performance Impact.

Management and Personnel Reviews.

Third Party Vendors.

Regulatory and Legal Risk.

Business Continuity Risk.

A Final Word on Monitoring.

Appendix A. Sample Investment Policy Statement.

Investment Policy Statement for Wilmington Family Office.

I. Statement of Investment Objectives.

II. Asset Allocation & Rebalancing.

III. Guidelines for the Selection of Fixed-Income Securities.

IV. Guidelines for Selection of Equity Investments.

V. Standards of Performance.

VI. Selection of Managers.

VII. Responsibilities of Managers.

Appendix B. Sample ADV Part II with ADV Schedule F.

Appendix C. Hedge Fund Manager Due Diligence Questionnaire.

I. Background.

II. Investment Process, Strategy, and Philosophy.

III. Business Plans.

IV. Manager Selection and Research.

V. Manager Monitoring and Risk Management.

VI. Performance and Fees.

VII. Compliance and Client Reporting.

VIII. Personnel.

IX. Operations and Administration.

X. Taxes.

XI. Performance (See Attached – Appendix 6).

Attachments.

Appendix D. U.S. Equity Long/Short Managers.

Proposal Questionnaire.

A. Organization.

B. Investment Professionals (Product Specific).

C. Investment Philosophy and Process.

D. Trading Process and Systems.

E. Performance.

F. Composite/Product Information.

G. References.

Bibliography.

Chapter 1.

Chapter 2.

Chapter 3.

Chapter 4.

Chapter 5.

Chapter 6.

Chapter 7.

Chapter 8.

Chapter 9.

Chapter 10.

Index.

"…a comprehensive guide to the process of selecting hedge fund managers, and it flings open doors into a traditionally secretive world." (The Investment Professional) EDWARD J. STAVETSKI is Director of Investment Oversight and Chair of the Investment Committee for the Wilmington Family Office. He is an active member of the CFA Institute and served as a board member and past president of the CFA Society of Philadelphia, Inc. Stavetski was a regular contributor to TheStreet.com, Investopedia, and RealMoney. He received his bachelor of arts in chemistry from West Virginia University and has held NASD Series 7, 63, and 65 licenses.

Filled with complicated investment structures and vehicles, the opaque world of hedge funds can be hard to get a handle on. But that doesn't mean you should avoid the opportunities it has to offer. Whether you consider hedge funds an asset class or just an investment vehicle, you need to understand some of the technical aspects to structure, the comparative performance statistics, and the continual vigilance needed to successfully navigate this field. That's why investment expert Edward Stavetski has written Managing Hedge Fund Managers.

Page by page, Stavetski skillfully examines both the art and science of hedge fund investing. Starting with the role of the Investment Policy Statement (IPS)—where investor guidelines and expectations are set—the discussion flows to quantitative measures, qualitative rankings, and monitoring your managers. Along the way, Stavetski breaks down each step of the due diligence process and focuses on critical tasks, reviews, and questions.

What is stressed time and again throughout the book is that while numbers and calculations are important to understand, they don't necessarily provide you with answers, but rather help you ask the appropriate questions. And with this book as your guide, you'll quickly discover the right questions to ask in your hedge fund search.

Topics covered include:

• The virtues of emerging managers versus large established ones and the risks involved

• Casting a wide net to find a new manager

• How to decipher the mind-numbing statistics that often surround hedge fund investing

• The various concepts of risk and the real exposure you face as an investor

• Researching qualitative factors that impact a hedge fund

• Highly detectable factors that were responsible for the implosion of previous hedge funds

Whether you're an institutional investor building an entire portfolio or a high-net-worth individual looking for a single fund, the process by which you evaluate hedge funds should be comprehensive and consistent. With Managing Hedge Fund Managers as your guide, you'll learn how to approach this endeavor in a way that will improve your portfolio's overall return and put you in a better position to avoid the pitfalls that plague so many other fund investors.

"Edward Stavetski's Managing Hedge Fund Managers clearly and comprehensively explains everything you ever wanted to know but were afraid to ask about the hedge fund industry. Given the carnage in the world's stock markets and the recent hedge fund turbulence, Stavetski's book is especially timely and has added value today."
—Douglas A. Kass, President, Seabreeze Partners Management, Inc.

"The publication of Managing Hedge Fund Managers is especially timely. The hedge fund community has been rocked by uncharacteristic performance, manager blow-up, and massive fraud. Ed's book will prove to be an essential reference for anyone wanting to perform—or rethink how they perform—appropriate due diligence on hedge fund investments."
—Scott Welch, Senior Managing Director, Investment Research & Strategy Fortigent, LLC

"Stavetski's book is perfectly timed for a market that is more cautious and skeptical than ever. In a readable style, this book is packed with practical insights and tips for investors who are exploring hedge funds or currently using them in their investment strategy. This book is must reading for an one involved with hedge funds."
—James Ware, author of Investment Leadership and High Performing Investment Teams, international speaker on leadership and culture in the investment industry, founder and President of Focus Consulting Group, Inc.

"Managing Hedge Fund Managers is an indispensable guide to a confusing, murky task. No book can guarantee it will make you money. But I feel confident this volume will surely save you from losing money! Not reading this book will put investors in harm's way."
—Theodore R. Aronson, Founding Partner of Aronson+Johnson+Ortiz, LP Former Chair of CFA Institute

"Ed Stavetski has written a superbly informative and extremely well-timed book on how to evaluate and select hedge fund managers. His in-depth knowledge and firsthand experience allow him to cut to the core of what's important to look for in a manager, providing the potential hedge fund investor with an immensely valuable tool. A must-read that enlightens and entertains, all at once."
—Daniel J. Barnett, CEO, Revere Capital Advisors LLC