These Are the Best of Times

There is one sentiment that we are hearing more frequently these days from friends in the industry. "Aren't you guys trying to launch a hedge fund at a bad time?" After all, money was flowing into emerging hedge funds through July, and now that flow has slowed to a trickle as many investors have fled to bigger, more established names. The sub-prime mess has made people fearful of potential blowups, and their first emotional reaction tends to be panic selling.

Well, we don't have any sub-prime issues here, nor will we, but that is not the point. If you were to ask most investors (accredited investors, fund of funds, large institutions, etc) if they invest rationally or emotionally, nearly all would answer that they invest rationally. In fact, they would pride themselves in their ability to outthink the rest of the market. Yet when the black swan hits the market, they are among the first to retrench. By moving towards the perceived safety of a large entity, they are exhibiting all the wrong tendencies most people want in a money manager ("Even if I'm wrong, everyone else will be wrong too, and I won't look bad in comparison. They can't fire me for being with these bigger guys"). This drives the investment decision far more than anything else. So much for their clients' money. So much for their investment mandate. So much for rational thinking.

We saw this in commercial banks in 2000-2001. They had unexpectedly large inflows of capital as investors fled investment banks during the bear market. The safety that investors sought was merely an illusion; commercial bank portfolios performed terribly during that time, even relative to the market. Investing is outside the core competency of a commercial bank, and millions of investors paid the price.

The truth is that it is a wonderful time to launch. Our strategy is built to work under any conditions, but conditions such as these are ideal and should get us a couple of more points a year versus our long-term expectations. We explain it in very clear, easy-to-understand terminology with an emphasis on how the math works. We only show the worst-case scenarios, never the best case, because it helps people to understand their downside risk. Plus we like to surprise on the upside fairly often. All the hedges we put in place leave a clearly defined range of expected returns that fits well within most people's comfort levels. The lack of leverage and ample diversification are there to add more layers of comfort and safety. Many larger funds do not have these protections in place, so the safety sought in turbulent times can sometimes be elusive. Bigger does not always mean better, and almost never means safer.

Times like these tend to weed out most of the emotional investors anyway, so the investors we attract now will most likely be with us for a very long time. Truth be told, the market desperately needs the emotional investors. The volatility they bring to the party helps us a great deal. But they will not be investors in our funds.