As savers today we collectively invest 3 tn into vehicles that mostly seem to hide on exotic Caribbean islands, can only be found through a bundle of more or less structured Excel databases, word of mouth and subscribed manually over fax with service providers that screw up at every possible step along the value chain…everybody agrees: we hate all of this…and on top the press is full of criticism on hedge fund returns!
So, who’s mad here? We all are.
But we firmly believe technology will bring the change to make hedge funds an asset class that adds the value all of our savings piles need. Here’s why…
To begin with: We don’t invest smart enough
We have a problem: We consistently miss our investment goals and have been doing this since decades. Simple facts like the one shown in the picture below illustrate this.
(Based on the research of Victor Haghani and his TEDx Conference lecture, St. Paul, 2013)
One million passively invested into the US stock market in 1900 would have amounted to 30 billion today! In 1900 there were about 4’000 millionaire families in the United States. Generations later, every one of those families have grown to 30 about families today. This would imply we should have about 120’000 billionaires today, but only 400 “survived”. So where are the billionaires? What went wrong? Some reasons are certainly obvious:
- Consumption and taxes
- High commissions and fees as well as transaction and business costs
- The biggest problem is ourselves: bad investment decisions
So then, can hedge funds save us from being bad investors? We think, not today …
Hedge Funds: a Loser takes it all market
One could ask if this market is really working or why not. Many markets we know are the Winner takes it all markets. This is certainly true for Internet search, Social Media, Entertainment/Music, Transportation, and even Software, Sports, and Logistics. But what about Financial markets and Hedge Funds?
Size – “Hedge funds of all sizes are now back past their pre-crisis peak. Global hedge fund assets now stand at $2.869 trillion.” (CNBC,
Concentration – “100 largest hedge funds manage 61% of industry
assets.” (COOconnect, 2013)
Flows – In 2000 10% of managers managed 75% of HF AuM, today it’s over 85%
First Conclusion – Well, the rule seems to apply also in the Hedge Fund market and the Winners (top 10% of managers) take it all (85% of AuM)
Wait a second…!
Looking at almost any study on long-term returns of hedge funds you find 2 things:
- The asset class performs better than stock markets
- Small/mid sized managers return way better than larger peers
Below is returns analysis from one of those studies, comparing small to large managers:
(Source: BEACHHEAD CAPITAL MANAGEMENT – Performance of Emerging Equity Long/Short Hedge Fund Managers 2003-2012. Feb. 2013)
Over the past ten years, SMALL managers returned 7.56% per annum and outperformed BIG peers by 220 bps per annum. And small managers had a Sharpe ratio of 0.57 vs. 0.39 for larger peers over the past decade.
So, it is basically confirmed: The Losers take it all
Why we consistently invest with the Losers
Basically it all comes down to a transaction cost problem which makes us look sheepish as hedge fund investors today:
- As many animals we love herding and we build on heuristic searches within our known and trusted network. And at Fundbase we often hear from investors: “we know our managers“, sounds like a trusted but extremely limited universe.
- Secondly, we are blind because most data on alternatives is of low quality and not properly maintained and there is not a central source for that kind of information. Investors are then often overloaded with unstructured, incomparable, and not assessed information.
- Last but not least, we all tend to cover our back. Risk seem too high compared to possible rewards since psychologically the transaction costs are deemed way to high.
Prediction: Technology will change the hedge fund industry forever
We see innovations and new business models in the finance industry arising almost every month. Alternatives are not an exception. Here is how it is going to play out in our eyes:
- Global peer networks will build trust among each other, engage in collaborative investing, share investment opportunities etc.
- Technology will dis-intermediate transactions and the exchange of information becomes free. Investors will only pay for what they get.
- Lastly, investors get direct access to hidden pearls and the Winners will become visible to a wide range of investors, also based on the wisdom of the crowd.
- Investing will become a matter of clicks and a seamless experience rather than a laborious and costly process with many breaks and 3rd party hick-ups.
Today we are sheep, technology will enable us to become investing wolves!
The result: Tech creates a new asset class
We predict Tech will add at least 4-5% on returns for hedge funds within the next 12-36 months. Practically risk free. So from an assumed (already healthy) annualized return of 9.3% since 2000 we can assume to end up with annualized returns of over 13%. Here is is how we think its going to add up:
(source: Eurekahedge index Jun 2000 – Oct 2014 minus assumed transaction costs of 170 bps=9.3%, Fundbase analysis)
The five ingredients are:
- Select smarter! min +220 bps from tapping small/mid cap managers
- Get a deal! +50 bps from lower fees due to (seed) deals
- Cut transaction costs! +50 bps less broker’s fee, intermediaries, due diligence
- Ask your custodian! up to +60-75 bps from reduced custody fees
- Operate smarter! +10 bps from lower data costs and HR/IT resources
This is not just dreaming, it’s coming closer to all of us. We saw this kind of innovation and disruption in many other industries (Airbnb for hospitality or Uber for transportation) but also in financial markets (Angellist for venture capital).
At Fundbase this keeps us up at night and we will not stop until we deliver to investors their well earned 5% extra.
Fundbase is a Swiss/US based technology venture executed by seasoned entrepreneurs and backed by sophisticated investors. At Fundbase we believe institutional investing into alternatives should be as easy as buying low cost ETFs. We make it happen with technology. Visit us at fundbase.com