Welcome to the first episode of our Capital Advisory Group’s podcast
series, What is the role of Hedge Funds today?
Following the results of our 2019 Institutional Investor Survey, Kenny
King, Head of J.P. Morgan’s Americas Capital Advisory Group, dives deeper
into the findings and discusses the trends we expect to see for Hedge Funds
Hello, listeners. My name is Kenny King. I'm the Americas head of the
capital advisory group. I'm thrilled to be with two of my good friends,
Paul Zummo, chief investment officer, JP Morgan, alternative asset
management, and Michael Gubenko, global head of hedge fund due diligence
for JP Morgan, global wealth management. Thank you both for being here for
our inaugural podcast episode.
Thanks for having us, Kenny.
Thanks, Kenny. Great to be here.
We recently released our annual investor survey, and even after a
challenging 2018, investors remain committed to hedge funds. On the other
hand, there's definitely frustration. Hedge funds had struggled to produce
alpha, alpha being defined as beating a benchmark. Investors continue to
believe that they're getting more beta, beta being defined as just getting
the benchmark rather than getting a true source of alpha and a
differentiated experience with their managers.
Seventy percent of investors did not meet their target return, which has
me, uh, scratching my head. What is the role of hedge funds today? Paul,
Michael, how are your businesses thinking about the role of hedge funds in
you want me to kick off?
Sure. Why don't you start it off.
Alrighty. Look, I think that undoubtedly most investors who have been
investing in hedge funds have been frustrated with the level of returns
they've witnessed out of their portfolio for the past, you know, call it
five to seven years as a whole. And I think some are starting to alter what
their expectations are for it, and I think that's the exact, like, the
wrong place to start here.
And so, here's how we think about it
within wealth management. We use hedge funds as part of a multi asset class
portfolio. We are responsible for managing people's wealth, uh, across
generations, and so most of the money that we manage is in multi asset
class solutions. And if you think about that, it's really we break it down
into the basic building blocks, which are equities provide growth, fixed
income provides stability, and then we've used hedge funds for
So, you know, one of the objectives that we always set for ourselves is,
well, um, what is the beta that we expect to come from our hedge fund
allocation? We manage our, our, our allocations to be anywhere between a
0.2 and a 0.3 beta to equity markets as a function of where we are, um, in
a cycle, today being later cycle.
And so, um, we look for a minimum of 200 basis points of alpha on top of
Yeah, I'd say that the vast majority of our clients are looking
at hedge funds for a source of, of diversification to their other asset
classes, but I'd say that, you know, that's not necessarily the case across
the board. And maybe more broadly, the way we work with clients has become
increasingly, and the solutions in which we provide, has become
increasingly customized, increasingly bespoke, um, over the years as well.
with the industry close to $3 trillion in assets, are you finding sourcing
managers more challenging today than five years ago?
I would think for, I would think for both of us, right, you think about
this industry, reached an all-time peak last year despite the way that you
commenced this conversation about frustration, so clearly there's still
money flowing into it. Um, and, you know, how many participants are there?
North of 8,000, maybe even, like, 10,000, especially as, um, um, as you've
seen growth outside of the core market of the US and even traditional
Europe, right, into more emerging economies of the world.
And so, both of us I think view this as we've got to find the best in breed
that there is, and so, you know, the number of managers that we cover is
well less than 1 percent cover, meaning, uh, invest in well less than 1
percent of that, that, that total universe.
Well, there's no, no shortage of, of managers. You know, there's always,
uh, there's the difficulty of finding good managers, definitely you've seen
alpha come down structurally over, you know, 10, 20 years, and especially
in certain strategies.
So, maybe just take, you know, a couple different areas. Um, like, fixed
income replacement. So, as the prospect for rising rates was really on the
mind of many investors, I think people were often turning toward hedge
funds as a fixed income replacement, more kind of multi-strategy-oriented
And, you know, private credit would be another one. Uh, there's obviously
many different forms of private credit. Um, on one hand the, you know,
direct lending space is, is much more commoditized, but there's a lot of
different, you know, substrategies within private credit that are less
trafficked and, again, offer both higher rates of return and higher alpha
Um, volatility. So, uh, volatility obviously increased in the fourth
quarter, but I think there was concern, just given the level of equity
market valuations and a prospect for higher volatility, and that led
toward, um, many more conversation around quantitative investments,
specifically statistical arbitrage and specifically on the shorter term
oftentimes machine learning-oriented statistical arbitrage, which is a
beneficiary of a heightened volatility environment.
We're definitely seeing, seeing an increased focus on quantitative
strategies. Maybe you can define or tell us what are the key drivers
because you've definitely been a big proponent of quantitative strategy.
Right. Yeah, I mean, you know, it's, it's, it's funny, depending on your
experience in quant, you could kind of come away with very different
conclusions. Or if you're reading the newspapers, you'd see, you know—I
don't know, you'd open it up on Monday and it, it, it says quant did, did
terribly. You know, Tuesday it's done great. You know, Thursday someone's
going out of business.
So, it, it, it's too large, you know, just to say quant, it's just too
large of an area. you could really slice that quant world into a lot of
different substrategies. I mean, commodity trading advisors on one hand,
CTAs, risk, you know, risk-parity based things on, on another.
Um, and they've performed quite differently, and even, you know, taking a
space like statistical arbitrage, if you look at machine learning focused
managers, they have actually performed, at least recently performed, much
different than the traditional methodologies as well.
So, growth in data is obviously enormous, both structured and unstructured
data. The cost of computing power has obviously come down. That plays into
the hands of new managers that are starting up, helping them compete. Um,
obviously new techniques. You know, natural language processing, machine
learning, all that is really, really important to generate new alpha
signals and to be best of breed and to try to, you know, compete for a
small manager and startup manager with some of the larger players.
So, you know, we think it is definitely going to be increasing impactful on
the hedge fund industry, and that's really exciting, um, but it's obviously
wider investment management world as well. And, you know, I'm sure we'll
talk about long-short equities, but, you know, if you're a fundamental
long-short equity manager and you're not evolving, and, you know, you
really have to say how much alpha potential will be left, you know, looking
out three, five, 10 years, given the competition that is, that is emerging
in the machine learning space.
Paul, you make a great point, though. Looking at our survey, quant is
definitely the place people are looking to add where fundamental long-short
definitely did not have its finest moment in the fourth quarter. Definitely
feel like investors are definitely churning their portfolio in the
fundamental long-short space. Michael, what are you seeing
Um, so, let's talk fundamental long-short for a minute. Um, where I started
here is, is a function of where we are in the cycle, which we think is late
cycle. We have been de-emphasizing, um, our strategies that contribute to
that beta target that, uh, that we run. And so, that inevitably means that
we've been, um, shrinking our exposure to both fundamental long-short and
[venture], which a good percentage of the [venture] universe, given where
they are today, um, given the lack of real distressed opportunities or
dislocated credit is largely if you have the ability to invest across the
capital structure, invested, uh, invested in equities.
And so, um, you know, I, We think that there is, um—there are pockets of
really high-caliber people who have the ability to be generalist investors
wherever they go, and then there's investors within long-short that also
bring that specialization to bear. And there are sectors that, um—where you
have a wider universe of stocks, more dispersion. Take tech and health
care, to be exact. So, either that sector focus or regional focus we think
is one that could lend itself to, uh, alpha potential
Paul, it feels like [indiscernible] for alpha and long-short, people are
looking east, you know, from the—looking to go to Asia. It feels like
that's where—you know, I've been traveling the last two weeks, and it feels
like every conversation I have with an allocator for pension, a family
office, it feels like everyone wants to increase their Asia exposure.
Do you think there's probably more inefficiencies in Asia which may allow
Yeah, look, there's a number of things. Um, I mean, many of the Asian
markets were even—sold off even more and obviously more bought quickly, so
I think that's caught people's attention. Opened up China is, is, uh, is
another one. The quality of—well, the quality of managers, though, is, is
probably the most dominant one.
You know, the quality of managers today versus five or 10 or 15 years ago
has risen dramatically, and ultimately, you know, at the end of the day,
you're going to take strategy views and market views to some degree, but
it's really all about manager selection. So, I think people can get much
more comfortable with the manager, uh, manager selection side.
And then, yeah, you know, alpha should be higher there. Inefficiencies are
higher. You don't get—arguably you don't get as much of the crowding as, as
you do in, in other places, although, you know, it certainly exists there
So, for all those reasons, we've, you know, pretty consistently—and again,
not that it's, it's a dominant piece of what we're doing in long-short. US
is still the largest. But we've definitely incrementally done more and more
I would say the only thing about that, like, if we're just focusing on the
equity side of the equation, what we've generally seen—and no doubt that
that market's become more institutionalized, but it also tends to run
at—with higher nets than we see elsewhere throughout the world, right?
Like, there's less discipline on the short side. It's been a market that
trying to capture the beta, maybe not always structurally positioned that
way but try and time it as well.
And so, I think there's, there's, there's aspects of investing there that
you'd have to be conscious of as you step into that market, too, which is
it tends to be a higher beta market. They tend to lean longer. And so, to
that—it contributes to that beta profile.
We've talked about investing in APAC. How are you thinking about your
exposure to European managers?
I mean, Europe seems to have a lot of different, uh, issues. You're
constantly hearing about Brexit and different, uh, nations, but it seems
like that could be a potential source of opportunity.
I, I know Michael has the answer on Brexit. He knows exactly what's going
So, so Europe, um, let's start with it on the, on the equity side of the
equation. Um, the number—we talked about the number of managers earlier on
in this conversation. Number of managers in Europe structured as hedge
funds has gone down meaningfully as a function of the fact that that region
mostly catered historically to European LPs and European LPs have just
sought greater liquidity, and that's been achieved through UCITS
So, I think that there's just not as deep of a pond to fish in over there
on the equity side. And then what else does that leave in Europe? It's,
right—obviously there's a credit market. It's smaller than it is here. Um,
but comes with certain inefficiencies, especially because on a regional
basis, right, like, sourcing of paper could be done at a very localized
But I, I, I, I mean, I think, you know, principally the way that I see
European exposure sort of manifesting itself through portfolios is, is more
from the macro side today in terms of people trading either sterling or,
or, or rates. And, I mean, that is, that is not—those are not structural
allocations, and Brexit has played a large component of that and what the
ECB's, you know, monetary policy is.
But Europe is, is frankly just in summarizing, I think it's just a smaller
pond to fish in from a management perspective.
Yeah, we would agree. I mean, on a traditional hedge fund side, we would
definitely agree. I mean, where we're—so we're not doing, you know, we're
not really bringing on any new allocations on a traditional hedge fund side
in our focus on Europe. Happy with kind of what we have.
I'd say it is different on a private credit side. So, you know, obviously
there continues to be a lot of pressure on, um, you know, on weaker banks
in, in Europe to, uh, you know—there's increased capital charge. There's
increased regulatory pressure to, uh, to push out non-performing loans. And
obviously there's, uh, a tremendous amount of new and existing managers
that are, you know, private credit in between hedge funds and private
equity to kind of capitalize on that.
So, we've built up a lot of allocations, uh, in both kind of dedicated
pockets as, as well as kind of hybrid, um, client portfolios that have
capitalized on that. So, you know, non-performing loan focus or reg cap
focused or other lending oriented strategies.
In our, in our most recent survey, we asked a question, uh, for the second
time on ESG, so environmental, social and governance. What's interesting,
though, is the term "impact" has come up. Paul and Michael, what is your
view on ESG.
I'd say the quality of the products, uh, on the hedge fund side is a little
spotty, uh, which is why, you know, again, there are some good ones, but
it's, it's, it's not a, you know, it's not a tremendously deep,
But, look, the, the challenge of the ESG space is that a lot of people want
a lot of different things. It's hard to meet the marketplace demand, and,
and thinking about how does is that best implemented on the hedge fund
side, right? Like, for just on an exclusionary stock basis is, is generally
considered kind of not enough and, you know, something of kind of
On the other hand, if you kind of go to the other extreme and, and focus
much more on impact, I think investors' reaction is going to be I, I want
alpha first and foremost. So, you kind of have to have something in
between, and that's kind of where we landed, which is let's focus on alpha
first and foremost but let's focus on managers, um, that oftentimes are
thinking about ESG from the standpoint of, of capitalizing on the
structural growth and change that ESG is creating, and trying to identify
companies that are increasingly becoming more ESG focused and are going to
benefit and perhaps get higher, you know, higher valuations and multiple
because of that.
Yeah, what I would say, um, to address your question, Kenny, on that front
is I think part of it is why is—yes, why hedge funds have lagged the rest
of the marketplace in ESG adoption. I think part of it is the fact that
they run unconstrained strategies by their very nature that tend to be
concentrated in, in what they do.
So, this concept of looking for best ideas is purely focused on, right,
like, where can I achieve the greatest risk-reward nature of things?
So, um, you know, I think it is going to be hard. I think you do have to—it
is, it is different for everybody, and I think what you're doing is, is the
right thing. We've, you know, just within wealth management it's been much
easier to tackle from a traditional perspective. And so, we've been really
focused on it. We hired someone to lead our sustainable investing efforts,
and what we're focused on is, uh, delivering multi asset class solutions,
um, in an ESG framework.
Yeah. Paul and Michael, I want to ask you about new launches. So, in, in
our survey, 43 percent of investors recently mentioned they allocated to a
new launch in 2018. We've seen a growing interest in new launches. Paul,
how does the asset management think about new launches?
Sure. Um, so historically we've always been extremely dedicated to the
space, so, you know, 65 percent of managers with whom we've invested on Day
1 have been emergent.
So, I mean, the first question is, like, what are you exactly looking for
with emerging managers? And, like, for us oftentimes what we're looking for
is access to a manager and a strategy that doesn't exist at a larger size,
so it's not scalable. So, you know, on, on the quant machine learning side,
you know, maybe it's a manager that can only—only has capacity of $500
million and it pays to get in early. Um, because, you know, over and above
that, they're going to change what they're doing in terms of the time
horizon's going to go out and it's not going to become interesting, so you
have to get in early. There's value in getting in early.
Um, or, you know, the fees and kind of the deal that you're getting is
sufficiently attractive that you're compelled to kind of invest in it at an
But more broadly, I'd say our efforts have been focused mostly on the quant
space, and strangely in long-short equities, we're actually finding—because
you have to say, like, where does the inefficiency exist? Oftentimes in
emerging, we would actually say there's an inefficiency that exists for
managers that have been around a while that have been forgotten about in,
in a marketplace.
we found $2, $3 billion managers that we don't normally invest with in
Years 3 or 4, but, you know, that are still offering attractive terms that
we felt, everything else equal, was a much better, um, opportunity than
necessarily getting excited about, you know, the new manager that's
launching in long-short.
That's great. Michael, as you sort of think about, uh, the year ahead, how
are you thinking about the managers in your platform? Are you thinking,
expecting, lower turnover or higher turnover? Neutral?
Hopefully not too high, right?
Yeah. Definitely don't want it to be like in years past. I, I, I think, um,
just like if you were to ask any hedge fund manager, "How do you feel about
your book today?" right, they, they love their book.
Talk to me at the end of the year.
Look, I, I would say I think it's important for us to reflect on this. We
were disappointed in last year, but the setup was really good. Rising rate
environment. We think that, that QE had naturally suppressed, um, the alpha
proposition for a host of different reasons. And, you know, you asked about
targets beforehand. I think one of the other things that hedge funds have
to do is they have to provide natural diversification to a portfolio. And
sometimes we're so in our hedge fund world that we talk about beta and
alpha and this and that. I think part of it is as simple as what's the
return relatively to a 60/40 portfolio, right?
That's a great point.
Um, we don't only manage portfolios of hedge funds, so we have a, a bit of
a wider toolkit, and one of the things that we're doing is how do we use
hedge fund structures or vehicles to create, um, a, a risk profile and
something that has a more attractive fee associated with it. So, an example
might be, um, high-yield munis, right? We have a big US taxable client
base, um, and that market is one where you need specialization, and so we
could create a structure around that.
And that, that's a little bit unique, but we're thinking about how do we
complement what we do on the traditional hedge fund side by using the
vehicle to offer what we believe are attractive solutions to our clients.
Yeah, I mean, you need to innovate, right? And, and we're doing, you know,
we're doing the same thing. So, kind of working with managers to structure
solutions that work better for us. Part of it is getting fee savings, but
part of it is maybe carving out a small piece of what they're doing and,
you know, making that a, a, you know, making that a much broader
opportunity. Uh, co-investments would be another one. Um, and it brings
down fees, higher, uh, return potential. So, it's evolving.
That's great. Last question. If you had a crystal ball, what do you think's
a surprise we can expect in the industry in the next 12 to 24 months?
Well, if we had a crystal ball, it wouldn't be a surprise.
Yeah. Yeah, yeah, yeah. Well, yeah, I mean, look, on ESG, going back to
ESG, I, I, I think the impact of ESG in terms of how, you know, the growth
of ESG on a worldwide basis, on what it's going to mean for the hedge fund
industry, is certainly being underestimated. And similarly, you know, on,
on the, uh, on the quantitative side, machine learning side, you know,
like, when you're sitting down and, and talking to these managers and
really kind of getting into the weeds of what machine learning is, natural
language processing, and understanding obviously the impact not only in the
wider world but the impact, you know, on the investment management
industry, like, and, and, and obviously the growth in data and everything
associated with it, like, people get it. It's not a, you know, it's not a
surprise in, in one hand.
But I still think it's vastly underestimated. I mean, it's just, it's just
such shocking the, the, the impact and the power of it. And, yeah, I, I
still just think it's, it's dramatically underestimated and if people are
not paying attention, they're going to get run over.
I think you started this by saying that 70 percent of, uh, the, the survey,
uh, respondents were frustrated with performance. I think the surprise is
going to be the inverse of that.
Yeah. That's great.
That, that performance is going to, uh, outperform expectations. And so, I
look forward to the conversation that we have on the back of that.
There you go.
It's great to end on a positive note. Well, that's it for today's podcast.
Paul, Mike, uh, thank you for both providing valuable insights, and thank
you to our listeners for tuning in. Any questions in the meantime, feel
free to reach out to a JP Morgan representative. Thanks, guys.
Thanks very much, Kenny.
Thank you. Yeah, appreciate it.