Screening Hedge Fund Managers: Understanding the Investment Process

Mark Anson in his The Handbook of Alternative Assets discusses three fundamental questions as an initial screen before investigating further whether a manager might be suitable for your investment program. The three questions center on the manager's investment objective, investment process, and what makes him so smart (which we like to call "edge").

We think these are three very good questions. Unfortunately, Anson spends most of the discussion going through the hedge fund offering documents of a manager to discern these elements. The offering documents are legal documents, designed to protect managers from lawsuits. They are usually written in lawyer-speak and purposely contain much generality. Anson criticizes a manager who lists every trading instrument under the sun, but a manager may be protecting himself if there are multiple ways to get exposure or the area of focus is still evolving.

Instead, as an initial screen, we put some reliance on a manager's investment letters and marketing presentation in addition to the performance numbers. We want to understand what markets a manager looks at, his universe of investments, what inefficiencies he is seeking to exploit, how he invests and constructs his portfolio in a repeatable fashion. It is true that sometime the marketing presentations and investment letters are very bad (talking only about the strategy in general).

If the investment letters contain only the recent returns of the fund and published long-only indices, I begin to wonder if the manager is doing something unique. On the other hand, if the manager discusses some aspect of the market I have not thought about or gives me insight into a recent trade, I am more interested in the manager (good marketing!).

Really understanding at a manager's edge and process usually requires a meeting or meetings with the hedge fund manager himself. However, a hedge fund can offer through a solid marketing presentation and well-written monthly letters can provide strong hints of a clear investment objective and suggestions of a bonafide investment process.

The Handbook of Alternative Assets, Mark JP Anson. ISBN: 0-471-21826-X. Hardcover,
512 pages. May 2002.