Asset management revisited
Strategies in a Newly Competitive Era
Three Cornell University alumni experts in asset management offered their insights at a panel discussion held at the Four Seasons Hotel in Boston, Feb. 22. Nearly 70 alumni attended the event, which was moderated by Jeff Parker, '65, MEng '66, MBA '70, general partner, Parker Family Limited Partnership, and included an update on the Parker Center by Professor Sanjeev Bhojraj.While the panelists differ in their investment approach and areas of expertise, they agreed on several overriding trends:
What comes around goes around. "Cycles never go away," said David Breazzano, MBA '80, co-founder and principal at DDJ Capital Management. "Each new generation always thinks it is smarter than the prior generations, but that's usually just before they fall." Remember the ill-fated leveraged buyouts of the early 1990s? The market recovered with default rates going back down in the mid- to late 1990s, but then high-yield bonds came back and investors took more credit risk. The dot-com bubble came and went in the late 1990s through 2001 and sent default risk way up, but the markets recovered quickly. Consequently, Breazzano believes today's investors under-appreciate risk.
Past returns are no guarantee of future earnings. Hedge fund fees have appreciated over the years and show no indication of slowing down, and, at the same time, returns are way up, leading to record compensation for Wall Street analysts. Panelists agreed that although it's difficult to replicate past returns, the money keeps flowing in. Hedge funds can consistently make high returns only by increasing leverage, which means increasing their risk, and that's exactly what's happening.
Many investors overuse leverage to drive up returns. "Leverage is rampant; firms are levering themselves up three-, four-, or five-to-one to get their returns," says Arup Datta, MBA '92, managing director and portfolio manager at Numeric Investors. "There is a real lack of volatility in the market. When risk comes back, what will happen?" Breazzano echoes Datta's concerns, saying that investors keep chasing yield and levering up portfolios to augment returns. If one hedge fund can't honor its leverage commitments, the entire chain could be disrupted. Breazzano's parting words: "It could get ugly."
Size Matters. Bigger isn't always better for the investor when it comes to hedge funds. As firms with a fixed-fee pay scales amass assets, clients incur higher expenses. George Tall, MBA '82, who co-founded Burl Capital in 2006, says his new firm is trading off size for alpha generation. By outsourcing everything except alpha generation, he plans to focus more time on picking the right stocks.
Be Wary of Risk. Before ending the evening, Jeff Parker asked the audience what long-term rate of return they would be happy with as investors. A few people raised their hands at six to seven percent, a few more at eight percent, and the majority indicated they would be happy with a 10 percent return. A few holdouts felt they would only be happy with a 13 percent return, leading Parker to comment, "The only way to get 13 percent is to short sell or lever up; 13 percent requires risk."