Anatomy of a Redemption

I have personally been allocating to hedge funds for over 27 years. My Firm, Eagle’s View Capital Management, LLC has been allocating to hedge funds for approximately 19 years since its inception. One topic that repeatedly arises with investors is regarding portfolio turnover and exiting from Fund Managers. We are often asked how or why we redeem from a Manager. Within this article, I’d like to provide some brief reasons as to what might trigger us to redeem from a Manager. Please keep in mind that this is not meant to be an exhaustive list as each situation is different and has a variety of circumstances. Furthermore, this is merely a guideline of some of the reasons we might exit a Manager or a strategy.

 ∙         Manager hits our stop loss– When we invest in a new Fund, we have a general idea of how much we are willing to lose with the Manager. This figure is based upon our qualitative assessment of how bad we believe things can get with the strategy under a variety of conditions. Obviously, a global macro manager will need to have a wider stop-loss than a statistical arbitrageur. In part, this stop loss is also based upon prior conversations with the Manager as to outer boundaries of loss expectation, the Manager’s prior record, and simply the amount we are willing to lose with this Manager.

 ∙         Manager experiences style drift- In short, we want what we thought we are buying. If the Manager is no longer delivering what we had originally bargained for, we must re-evaluate the new direction and strategy as if we were evaluating the Manager/Fund for the very first time. This does not trigger an immediate redemption if we re-underwrite the strategy modification and endorse the evolution of the business. As the economic and financial market landscape is constantly evolving, so too must our Managers. Hedge funds are all ‘works in progress’ and continue to evolve to meet the changing market. That said, we must believe that the Manager/strategy continues to have an ‘edge’ and we must feel that the evolution of the business/strategy is appropriate in the context of the Manager’s experience and consistent with the Manager’s prior proven abilities.

∙         We simply get it wrong- There is no sin in making mistakes. The sin is not correcting these mistakes, once recognized, as quickly as possible. If we get it wrong, we get out as quickly as we can. We shed no tears and we don’t look back. It’s simply part of the human condition to make mistakes and last I checked; we are human at Eagle’s View.

 ∙         Manager is not delivering upon expectations- When we invest in a Manager, we have a certain set of expectations relative to returns and relative to risk management. We attempt to assess what we believe a strategy/Manager will deliver from both perspectives and we simply monitor the performance of the Manager visa vi those expectations. We are less likely to tolerate poor risk management than we are to tolerate performance that is below our expectations over a reasonable period of time.

 ∙         Inefficiency/Edge of the strategy has degraded or dissipated- Eagle’s View seeks to invest with Managers who are deploying strategies that have an ‘edge’ and positive expectancy. These strategies are often capitalizing upon a structural inefficiency in the market. Market inefficiencies are a zero-sum game, and we must constantly monitor the demand/supply equation of these inefficiencies. In other words, the ratio of the amount of inefficiency available versus the amount of money chasing that inefficiency. Most market inefficiencies will degrade and dissipate over time as they get arbitraged away. New inefficiencies are always being created based upon changing economic conditions and changing market conditions and developments. It is our job to monitor the demand/supply equation for inefficiency within certain strategies and attempt to be pre-emptive in exiting opportunities that no longer operate in a fertile environment and enter new opportunities that have arisen.

 ∙         Key Man turnover/loss- If the individual or team responsible for a sizeable portion of the Manager’s success leaves the Firm, we generally want out. We will sit on the sidelines and watch if/how that Manager can rebuild. In addition to the obvious loss of talent, the flight of a key individual or team may indicate something wrong within the overall organization. Either way, we generally do not want to sit still as the train is approaching. We’ll shoot first and ask questions later.

Again, the above list is not nearly exhaustive as there are many other reasons having to do with operational issues, personality issues, integrity, etc. that may trigger us to redeem at any time. While we do not make decisions to invest lightly, we are, at our core, traders of traders. We must stay nimble, aware, and opportunistic always. Historically, we’ve redeemed from about 10-20% of our Managers per year and we’ve tended to add a similar amount. That said, we have no guidelines regarding this. We hope to never need to redeem from any of our Managers. However, if it were necessary, we’d turn over the entire portfolio if we felt it needed to be done.

Eagle’s View Capital Management, LLC seeks to invest in a series of highly diversified positive expectancy investments, with a heavy overlay of risk management, due diligence, and diversification generally within ‘niche-oriented’ hedge fund strategies that experience little or no correlation to the broader market indices. We are simply looking for businesses and Managers who are capitalizing upon a structural inefficiency in the market. Our mantra of investing in non-correlated, ‘niche-oriented’ strategies continue to serve us well.