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Hedge Fund Monthly
 
Fund Life Cycle – Timing Your Investments

Shoham Cohen, ESC Financial Services

June 2007
 

In the investments world today, it's becoming fashionable to argue in favour of emerging fund managers, as more professionals in the industry – fund managers included – are realising the potential contribution that emerging funds can add to an investment portfolio.

I am happy with this trend. Consider, for a moment, that there are over a whopping 10,000 alternative funds out there. It means that there are many unknown talented managers; who are able to achieve better results than their benchmark, only perhaps that they are less popular or don’t have the marketing skills of the more well known brands.

Of course, the main challenge we face is to identify the next rising star among the new kids on the block. Therefore, one needs to implement stringent due diligence and other screening methods such as site visits, reference checking, among others to ensure that the star selected continues to burn brightly.

The ongoing discussion surrounding emerging funds is important, and should be regarded as a fundamental stage of rejuvenating an investment portfolio. Make no mistake about it, like most funds, new funds will go through the same cycle that the fund life cycle theory suggests: (a) introduction, (b) growth, (c) maturity and (d) decline.

Nonetheless, I still believe that these are the types of funds investors should start exposing their investment portfolios to. The more I look, the more I realise that low-profiled funds are unspoiled and could be a booster to a portfolio for the longer term. Historically, high profiled funds – in most cases – will add less value. I for one, seriously worry when a fund becomes too famous/popular, because it's more likely to be renowned due to intense marketing activities (based on historical performances and brand building) that may result with high exposure and inflow of investments.

The fund life cycle theory suggests that funds go through four stages: introduction, growth, maturity and decline. While I don't believe anyone can directly extend the life cycle of a fund, however, with the right portfolio management, an extension of a life cycle for the investment portfolio is possible.

About five years ago, when I first arrived in Asia, the industry's focus and excitement was derived by the balanced portfolio theory of 50% in traditional instruments and 50% in alternative investments. Everyone from financial advisors to private bankers, attempted to design their investment portfolios this way. Five years later, most professionals and investors are still holding on to the very same balanced approach, although many factors and drivers in the industry have changed.

I personally think that we should look after the betterment of our portfolios by evolving with the times. I argue that balanced theorists should allow the emerging fund managers to comprise up to 20% of their existing portfolios. Emerging funds should be thought of as the first step towards rejuvenating an investment portfolio – it could yield better returns, better capital protection mechanism, a longer term investment prospect for investors, updated investment tactics, strategies and tools. The fund life cycle theory is a more contemporary portfolio theory that may enable investors to boost their performances and protect against downside phases in a solid manner.

Having said that, many investors are under the wrong impression: that the right timing to invest in a fund is when it has a long track record and large assets under management (AUM). Timing is definitely a critical issue, especially when choosing to enter and exit a fund. The fund life cycle theory, however, suggests that the optimum time to enter a fund is when it has low AUM and less years of track record.

It's disturbing that many investors – mainly institutional investors – and family offices may significantly narrow down the number of fund managers, looking for at least five years’ track record and over US$300-500 million in managed funds. These funds are likely to have reached their maturity phase and have – in most cases – enjoyed their most fruitful period of returns.

A good investor should identify an emerging fund and allow a certain exposure to the fund. During the investment time lead, he or she should closely monitor the fund's progress from the introduction phase, all the way up to the growth and maturity phase.

In essence, we should never have any sentiments about our fund managers. The only sentiments we should have is towards our own portfolio. Once an investor feels that a fund is no longer productive to the portfolio, there should be an integration process with another emerging fund and a full replacement thereafter. While many professionals and investors in this industry may be aware of it, I feel that only few are actually managing their investment portfolios in such a way.

I personally believe that fund’s life cycle will be the next trend in portfolio management, and the future portfolio generations will comprise of funds in three different phases – introduction, growth and maturity. This will allow an enhanced timing management macro tool for investors and increased returns.

 

If you have any comments about or contributions to make to this newsletter, please email advisor@eurekahedge.com

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