Hey guys, I have some questions about when to exit private equity/hedge funds etc. For context, in addition to trading some of my own systematic strategies, I invest a proportion of my account in systematic Hedge Funds and Private Equity. I work a full-time job so it’s too much work to invest completely without external help. In addition, I select for funds that have uncorrelated return streams and this provides my overall portfolio with some level of diversification. The funds I invest in have a live track record exceeding 20 years because I value (rightly or wrongly) the ability of a fund to adapt to various regimes/market cycles. My question is: is there a reasonable way to assess whether I should pull the plug of an underperforming fund? How can I assess when a fund has lost its edge and is no longer a reasonable investment? This question is similar to “when should I stop trading a discretionary/systematic strategy in my PA?” but it’s a bit trickier due to the nature of hedge funds. Exiting a hedge fund incurs significant fees and exiting can sometimes take 3-6 months. In addition, once I’ve exited a fund, there are significant costs to re-entry should performance revive in the future. I don’t think a reasonable approach would, for example, be “generate a 200dma of the fund performance and enter/exit depending on whether the fund returns are above this ma.” This approach would incur too many fees. The other consideration that complicates the decision is the “fact” that the forward returns of private equity and systematic hedge funds tends to higher when the fund has incurred a drawdown. In fact, from my research (after trying to account for survivorship bias), I found that the steeper the drawdown, the better the forward performance, on average. Take trend following, as an example, I think forward returns for trend following strategies tend to be better after a period of underperformance. This has led some fund-of-funds to favoring a buy-the-dip approach. After thinking about this issue, my thoughts on possible solutions are: Don’t be concentrated in any individual fund. Then hold all funds “forever.” This will eliminate onerous entry/exit fees and prevent “selling at the low.” Of course, some funds will go to 0 and the money invested there will be a 100% loss. However, since concentration in any particular fund is low, this should be a survivable situation. Find the maximum Peak-to-Trough drawdown over the entire fund history and exit when current returns dip below some multiple of this drawdown. For example, if maximum historical drawdown is 30%, exit if current drawdown is 45% (1.5x). Never re-enter. This would open up the possibility of selling on the lows. In addition, there are not that many good funds in the world so this strategy would reduce your selection to “inferior” candidates over time. The benefits of this approach would be to allow greater concentration on funds that you have high conviction on (since max risk would, in theory, be capped) Please let me know your suggestions/comments. Very keen to hear what others think.
I have also invested in a number of hedge funds, CPOs and CTAs. I no longer have the CPOs and CTAs. I closed one Hedge fund. The hedge fund allocation was more risky then other others. They were long/short, mostly long. I found during the 15 months I had them, they did not replicate past returns during similar markets. They under preformed both up and down markets. I expected narrower losses in down markets and outsized returns in up markets. They did that in the past. So, I took a small loss 5%, but was down as much as 19% and was never net up. The CTAs had strategies too risky for me today (Mostly option selling) so as my risk tolerance changed, I left. Whatever reason you choose those funds, would you choose them today? Does that still fit your Risk/Return expectations? That answer gives you your plan.
An outsider looking in. I think I heard 1/3 of companies in the US market are privately owned (hedge funds/private equity/Berkshire/foreign investment). I look at personal debt of the US consumer. I look at commercial real estate (2008 all over again). I look at the fall of the solar/EV markets. Then I look at the 3 to 6 months to get out of a fund...With new stock market highs. I also look at the US debt...With a 6 months treasure over 5%. Yes, I would be in the market...QQQ. But (depending on the fund/PE), cash can be king sometimes...
Read your original subscription agreement. You acknowledged that you were an accredited investor. For HFs, they may have a redemption window with a notification date. Still problematic if they hold any PE or VC. You'll end up with your cash, but look hard at the costs of early redemption. If you had confidence in them they may simply be wrong or working a theme. Quantum, at one time, was buying up the fledgling cell companies in most of - the old Warsaw Pact countries. VC or PE are they nurturing something hoping for an IPO? Few will offer any liquidity without a substantial haircut. Often by moving assets from your deal to the current raise. This means you could wait a while - in this environment a lengthy period. They also have shitty batting averages, but one property going to IPO could be a lifetime win. These are worthless pieces of shit from a valuation standpoint until you approach the offering. Dreams, but this is why you buy them.
The post's question was not, should I invest in HFs or and PE. The question was when to exit. Just because someone is an Accredited Investor, it does not make them all knowing about risk/returns, estate planning, taxes etc. It certainly does not tell them when they were wrong to invest in something, and they should get out. It does not tell them the optimal time to get out. It just means they make a lot of money each year or have a lot of savings. Almost every successful Doctor I have every met knows little about any of this and they trust the advisor they hire to do that. You seem to prefer liquid investments. I understand that. For some, that is a requirement as they never know when they will need it. For some, these investments are meant to build wealth for their family. They have other liquid investments that cover their needs. They want as little short term income as possible, and as much long term gains as they can get. And any short term income should have some tax advantage.
From those many 1000s of backtests and optimizing I have the result that whenever the new max. DD is exceeding the current/old MDD by FACTOR > 1.80 then it is good to exit here. And not 1.5 as you suggested. That is from my empirical backtesting. Overall I find your strategy reasonable on other parts. Second, if the fund is very diversified on many different strategies, then it could be that as early as Factor > 1.70 could be reasonable to exit on new worse MDDs and never re-enter here again. But not earlier from my empirical testing over a very large samples size.
%% Good points Robert M; but you sort of proved his main points, because of the exit problems. For sure, not sure why any would want a hedge fund that underperformed {average}in a down market but many hedge funds get that right . ONE thing that makes REAL estate so good , its not liquid, expensive comissions + close costs; and liquid REITS tend to underperform badly. Dave Ramsey says fees to high. So having just put in a good word for illiquidity; prefer liquid markets. I dont care @ all about cash metals drawdowns, my cash business ,long term metals uptrend; + dont panic sell.........................