I did a lot of reading over the holidays. Losing myself in a good book, preferably one with a happy ending, was my way of unwinding after a year that’s been, in a word, fraught. Audrey Hepburn once said, “If I’m honest, I have to tell you I still read fairy tales, and I like them best of all.” Lately, I find myself in full agreement. Plots where the good guys finish first, the bad guys get what they deserve, and everyone lives happily ever after (at least on some level) currently have my almost undivided attention.
Unfortunately, the world seldom works that way. I can’t deny that I was ecstatic when Roy Moore was defeated in the Alabama Senate race, but there has been little else to celebrate lately in terms of folks getting what’s coming to them, good or bad. It’s true, you don’t always get what you feel you deserve, but to quote the 19th-century minister and humorist R.J. Burdette: “The world owes you nothing. It was here first.”
I thought that was fairly common knowledge, even among us happy-ending folks. So perhaps that’s why I was surprised to see the lawsuit filed in Franklin County, Kentucky, on December 27, 2017. In a 124-page complaint, a group of former and current public workers in Kentucky seek monetary damages from KKR & Co./Prisma Capital Partners, Pacific Alternative Asset Management Co., and the Blackstone Group, among others. The suit alleges the asset management firms invested 10 percent of the Kentucky pension in funds-of-hedge-funds investments, in support of a targeted 7.75 percent rate of return for the plan that did not materialize during the period 2010 to 2016.
Huh? So it’s the hedge funds’ fault that the total portfolio-targeted rate of return was not met? That seems to be a bit of a stretch, given the 10 percent allocation. But perhaps the bigger reach is that it was somehow incumbent on the hedge fund portfolios to (a) always generate positive returns and (b) generate specific returns as well. I’ve been in the investment industry for going on 20 years, and while I would agree there are a number of things that a fund manager does owe investors, those things do not include specific, positive return streams. I know that hedge funds in particular are sometimes marketed as vehicles for “absolute return” (a term I positively loathe), but that doesn’t translate into “absolutely positive returns in any market.” In fact, the definition of absolute return from Investopedia says merely, “Absolute return is the return that an asset achieves over a certain period of time.”
In my opinion, a fund manager instead owes its investors the following, at a minimum:
Fiduciary care: Fund managers should be willing and able to provide fiduciary care to their investors. This includes reasonable care of the assets in their custody, as well as managers working for the benefit of the investor rather than to their own advantage. We have a word for investment managers who don’t exercise fiduciary duty in their money management practice: defendants.
Adherence to the investment strategy: The manager has a responsibility to clearly articulate and demonstrate his or her investment strategy, and to reasonably adhere to that strategy. Significant deviations from the agreed-upon investment strategy (including leverage, liquidity, complexity, assets, markets, and so on) should be fully and immediately disclosed so the investor can judge whether such digressions are prudent and appropriate for the investor’s overall portfolio.
Transparency and communication: The fund manager owes investors enough transparency for them to draw timely and reasonable conclusions about the investment portfolio and the fund’s business and operations, as well as the current and potential returns of that portfolio. Granted, the level of transparency required may vary from investor to investor, but it is incumbent on the manager to provide whatever information is required for investors to both make informed decisions and sleep well at night.
Compliance with federal and state laws and regulations: See also, “Defendants.”
Honesty: Fund managers must be honest with investors (and themselves) about successes, failures, market forces, personnel departures and additions, returns, operational viability, and a host of other factors. Not every person who leaves the fund is fungible. Not every market is conducive to every investment strategy. What goes down doesn’t always go back up. The ability to face these facts humbly and honestly is the mark of a good money manager.
Of course, investors owe fund managers certain things too. They must make every attempt to understand the fund strategy and market, appreciate why they invested in particular funds, and not value low correlation only when the markets are going to hell in a handbasket. In short, investors shouldn’t bank on a happy ending, no matter what marketing materials, pension boards, or capital market assumptions may tell them. Both sides have to work hard, and work together, to achieve any kind of fairy-tale ending.