When coming to Boston, a lot of investors are intrigued by the depth of talent in the traditional mutual fund and increasingly the alternatives side as well. There have been transitions and migrations from Boston’s long-only establishments to the long/short side for many years. Especially since the financial crisis, clients have wanted more protection of capital or less volatility or less correlation with the markets overall, and this has certainly picked up more recently.

But if you take a closer look at many of the most successful firms, the organizational size, as well as the dominance of long-only strategies, are creating challenges. There are often natural impediments to managing true best-ideas portfolios. Things like mandate constraints, capacity limitations, internal politics, conflicts of interest, incentive systems, and even career-risk fears can create slippage between great research and the actualclient portfolios. On the positive side, the traditional long-only business is very well equipped for managing portfolios in a regulated, highly compliance-driven environment.

Shorting presents another challenge. There are shorts for hedging purposes and there are also shorts for alpha generation. Unconstrained managers not only come across great companies to own, but maybe as many companies with good reasons to short. Even the best short investors probably tend to benefit from it only 20-30% of the time; the other 70-80% of the time, it can be a costly drag on their portfolios. Figuring out how to short effectively and efficiently—to minimize the drag in bullish markets while still having the protection in place when the inevitable pullbacks happen — is a vital skill in this business. It is worth noting that a couple of the biggest owner-operated hedge funds in Boston don’t really short. They hedge their portfolio in a number of different ways.

As the bull market is underway, investors globally are shifting assets towards strategies like long/short, market neutral, hedged or tail risk protection. As always, it is recommended to take a close look under the hood to understand how much protection you are buying.

Marketing opportunities in Europe as German regulator opens up alternatives for insurance companies

Meanwhile in Europe, the German insurance regulator introduced a new decree that insurance companies can invest up to 7.5% of their portfolio into hedge funds without further regulatory restrictions. Starting 2016, due to the implementation of Solvency II, the larger insurance companies may invest upon their own risk analysis into hedge funds, even beyond the 7.5% ratio. It will be very interesting to monitor the learning curve of these new investors in alternatives.

Risks: Why the real risk of investing today may be in areas that cannot be captured through numbers

Today, most investors rely on quantitative measures of risk. But, there are certain types of risk and behaviors that can be hard to measure just by looking at the numbers. For example, how can allocators predict how a portfolio manager is equipped to deal with certain situations? How does his behavior demonstrate how he manages risk? Such questions are not as simple as a risk model and its numerical outputs. Can you measure how much conviction a manager has in his investments and how he has built that conviction? Is that conviction based on deep knowledge or stubbornness? Can you predict his most likely response to a downside move in a stock?

The Opalesque 2015 Boston Roundtable, sponsored by Maples Fund Services and law firm WTS, took place at the Boston office of Maples Fund Services with:

1. Ben Deschaine, Balter Capital Management
2. Jason Brandt, Maples Fund Services
3. Kevin Maloney, Gottex Fund Management
4. Robert Welzel, WTS
5. Luis Cortez, Essex Investment Management Company
6. Ross DeMont, Midwood Capital Management
7. Scott Utzinger, Crawford Fund Management

The group also discussed:

• Why capital raising mechanism for small or mid-sized hedge funds is broken, and what opportunities does this open up?
• Investing: Strategies for efficient manager selection after the crisis
  • How investors can get better after-fee returns in liquid alternatives
  • Outperforming by focusing on owner-operated companies
  • Investing versus information arbitrage
  • Opportunities in life sciences, energy
• Fees: Aligning interests or fight for survival?
  • Are high water marks always good for investors?
  • Investors are willing to pay for alpha, but often they have no idea how to measure it
  • Are private equity fee structures the way to go?
• Risk (continued): How investors and managers get fooled by recency and frequency biases
  • How crowding and liquidity shortfalls will affect your portfolio
  • Why the current contract note redemption process of hedge funds is one of the biggest operational risks
  • What if you find out that you are the only human trading in a certain security?