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- [00:05]
Bill Kelly
Welcome to Educational Alpha. I'm Bill Kelly, CEO of CHI association and your host. Bringing you on the ground conversations with business leaders, educators and industry colleagues from around the globe. Educational Alpha is sponsored by iCapital, the financial technology company with a mission to power the world's alternative investment marketplace. Part innovator, part educator and part navigator of the alternatives industry, iCapital offers intuitive, scalable digital solutions that have transformed how private market and hedge fund investments are bought and sold. With iCapital, financial advisors, wealth managers and asset managers around the world now have access to everything they need to deliver the return and diversification potential of alternatives to high net worth investors. To learn more, visit icapital.com in this.
- [01:03]
Narrator
Episode, Bill interviews Kenneth Hines, president of HFR, to explore the evolving landscape of hedge funds. Kenneth shares insights into HFR's growth from its inception in 1992 to its current position as an industry leader. The conversation delves into hedge fund strategies, performance benchmarking and the role of transparency in driving trust and innovation. Kenneth also highlights emerging trends such as the rise of pod shop structures and the growing impact of cryptocurrency and the importance of democratization in investment strategies. Listen in.
- [01:46]
Bill Kelly
Ken Hines welcome to Educational Alpha Morning.
- [01:49]
Kenneth Hines
Thanks for having me on.
- [01:50]
Bill Kelly
I appreciate you accepting the invite. Certainly spent some time with you and your folks in the Windy City. It's been a while, but I believe that we quote some of your work in the KAYA curriculum. You've been contributors to the Kaya content over the years. We've done some joint events with you folks as well, so certainly appreciate the partnership. It means a lot to us and hopefully a lot to the end investor that we all serve at the end of the day. And I want to spend most of our time today talking about the state of the union of the hedge fund space and nobody better to talk to about that than you. But before we get to that, I think most of your career has been spent building out the platform of hfr. But maybe a little bit on how you began and maybe the humble beginnings of hfr.
- [02:33]
Kenneth Hines
Absolutely. So I've been with HFR a long time. Guess what? It is now. 22 years I guess. I started in 2002. I was finishing up my MBA at the University of Chicago, which was focused on a lot of statistics and econometrics, which was great and gave me great knowledge and insight as I'm thinking about a lot of things that I work with every day now. Prior to that though, I had a lot of exciting experience in the trading which also is Very helpful as we're thinking about investment strategies and managers and things like that. So immediately out of undergraduate I was at the Chicago Mercantile Exchange and I was a financial options trader in the S and P equity options stock. So that was a great experience too and certainly has helped inform a lot of the analysis and insights that we.
- [03:25]
Bill Kelly
Have today and the year. Then you started HFR, was it circa 92?
- [03:31]
Kenneth Hines
That's when HFR was started. It was initially started by the founder and current CEO and chairman Joe Nicholas, way back in 1992. And so obviously I came along 10 years later, I guess you could say. But yeah, it's obviously been a business that's certainly is an institution in the hedge fund industry for celebrating. I guess we're now at 32 years of history and continuing some strong and exciting growth and leadership in the industry.
- [04:01]
Bill Kelly
So you came about the time Kaya started in 02. But if you think back and you may know some of the history Anyway, in 1992, what was the problem that HFR or the opportunity that they were looking to capitalize or problem they were looking to solve when they first created HFR at the get go? Because I would imagine hedge funds had to be measured maybe in the hundreds of billions of dollars. It certainly must have been south of a trillion back then.
- [04:27]
Kenneth Hines
Oh yeah, it was a very small niche cottage industry in the late 80s. And you know, you think about the origins in the industry, it really is an extension of private investment pools that really developed in the 80s. Funnily enough, the oldest hedge fund we have in the database has a track record that goes back to, I want to say, 1969 or something like that. It's really a long time. But Joe was working as securities attorney with clients that were interested in investing in the hedge fund industry and accumulated information in the late 80s and early 90s. Questions what hedge funds are out there? What strategies are they doing? What's their performance like? How do I invest in them? These were all really very much of a black box. It was very difficult to get information on any type of hedge fund. And as he started to accumulate information on what funds were out there and then circulate that information, then that sort of developed into the business of commercial database of hedge fund performance indices of hedge funds that talk to the central tendencies of the overall industry and certain strategies and all of these things as the businesses evolve. It's funny you think about it like that. In 1992, HFR predates most modern Internet and most spreadsheets and Excel and websites and stuff. Like that. It really predates most of that stuff, which is kind of fascinating when you think about where we are now, both.
- [06:03]
Bill Kelly
Then and now and back then, as you just point out. It must have been much more labor intensive with paperwork and US Mail, et cetera. Fax machines, Fax machines. Who knew and who remembers? But this data is itself reported. How do you gather it in the first place?
- [06:21]
Kenneth Hines
Absolutely. All the managers all over the world report their information to hfr, and that's the way it's been since the very beginning of hfr, is that managers provide the information. We are the industry leader, the institutional standard, most widely used repository of information on the hedge fund industry. So any investor anywhere in the world, obviously, and that goes from US, Asia, Middle east, throughout Europe, any investor is using our database and indices to make the decisions about the allocations that they're making. And we continue to see strong growth in all those ways.
- [07:03]
Bill Kelly
And discovery and transparency is critically important, especially at this stage of the market. And we could talk about your recent report on the US Elections in a moment, but could you just give the listeners, Ken, a little bit of a background as to when we say hedge funds, what are we talking about? How big is the market? How many funds? Is it still biased toward North America in terms of strategies? Who is the buyer? Just a bit of a thumbnail on the space.
- [07:28]
Kenneth Hines
Yeah, absolutely. Categorically. Hedge funds are private investment vehicles that are, people say, unregulated, although there's certainly degrees of oversight from financial authorities on hedge funds, even more so now than maybe there was in 1992 or 1995. The industry has grown significantly, most recently. We just put out a report on this in the last month, as we do every quarter. The overall total industry capital is very close to four and a half trillion dollars of total global capital, which is significant growth. That's a record level. That's with the benefit of inflows in 2024, just in the first three quarters of around $23 billion of new capital. And growth has been good recently in the last two years, I call the last seven quarters, you've seen net inflows in five of those. So even though you look back at the last five years, going back to 2019, it's been a volatile period of time for investors, for sure, navigating some very much uncharted territory and volatility. But the industry has done a very good job of navigating these more volatile periods.
- [08:48]
Bill Kelly
I certainly agree with that and certainly that last statement about the industry having done a good job of Navigating, but maybe with a little bit of wind at their face. And we've had a period, and maybe it ended in the beginning of 2022, but we had an extended period of coordinated monetary intervention where so much capital was coming into the marketplace and interest rates pinned to zero and volatility maybe lighter than it should have been. And it made it very difficult for a hedge fund, however you want to describe it in most strategies, difficult to perform relative to expectation. And it seems like the expectation came down to beating the s and P500. And maybe that is the mandate for perhaps some of the equity based strategies. But thinking about diversification and a risk diversifier, I think then, now and going into the future. There's always been a home for hedge funds, but I think that there's been this wind in the face given what's gone on. Is that reality or just my perception?
- [09:53]
Kenneth Hines
Yeah, I think that low interest rates are absolutely a challenge. You know, we've had a period over the last 10 or even 15 years where you've had historically low interest rates a few different cycles for a few different reasons. They call it quantitative easing now and there's other words for it as well, certainly stimulus measures and things like that. And so those create a lot of, I guess you could say artificial volatility. But they also create challenges as to the overall level of carry that strategies can generate. At the same time, rallying equity markets are good, but great hedge funds really differentiate themselves when you have markets that are declining. Some people like to benchmark performance to the S&P 500. People have different reasons for doing that. They kind of think of it as the opportunity cost of what allocations they can make. It's a little bit of a misguided benchmark, I think, to just be benchmarking to the S&P 500. Because even for a strategy that has a high amount of equity market exposure, it's certainly less than 100% if it's long and short. And then the further you get away from the equity hedge strategies, the less relevant that become. Certainly event driven strategies categorically have exposure to things like distressed and M and A and credit, which are correlated with S and P, but they're very different relative value. Obviously primarily credit and arbitrage and more of a fixed income based exposure. And then macro is really primarily trend following futures or discretionary fundamental macro is the lowest correlated to equity markets at all. So really kind of across the board, the suitability of benchmarking to The S&P 500 is not really the most logical benchmark for investors to be using.
- [11:59]
Bill Kelly
I absolutely agree with that. I think too often it might be the expectation, but rarely is that the logical benchmark. Just a couple other table setting things in the industry that I want to come back to. Hfr, Ken, so do you have a proxy on the number of hedge funds offered in the world and then is it decidedly still majority North America?
- [12:18]
Kenneth Hines
Absolutely, very close to 10,000. In terms of the overall number of funds, certainly in terms of the location of the physical fund, it is skewed towards North America. Although they are located globally for sure. Throughout all of those areas, Asia, Middle east and Europe, we're seeing increasingly funds launching in places like the Middle east. For sure. I think it's also, as you think in the current environment. One of the interesting developments, and we can talk about this later, is an index that we've launched recently is this Pod Shop index, which you may have seen and that we came out last couple of months. And it's funny that people think Pod Shop, maybe there's five or ten, there's like hundreds, hundreds of remotely located pods feeding into a single vehicle. So there may be a main home office for the fun, but where it's located becomes more and more of a elusive kind of concept because it's kind of located everywhere and it gives it a lot of advantages to be they may be located. You know, you got a bunch of funds in New York and Park Avenue, but there's also pods located all around the world that are specializing in certain trades that they have unique insight on by where they're located. And increasingly we're seeing pods launching in Dubai. So that's a trend that I expect to continue as well.
- [13:53]
Bill Kelly
So I made a note of that. Ken, I'm going to come back to that in a moment, but to stay in somewhat of an order here, I want to come back to hfr. And now maybe the founding principles and the revenue model circa 1992 versus 2024, and maybe they're generally the same, but in order of magnitude and number of indices and research, I assume that you have expanded dramatically since then. But what Does HFR circa 2024 look like and what drives the revenue model inside of hfr?
- [14:23]
Kenneth Hines
Yeah, I mean, we provide value to our client base of investors, of fund managers and investors, includes both asset owners as well as hedge funds themselves. And they license our indices for benchmark use, they license our indices for product construction, construction of tracking funds and things like this. And they license the use of our data on our hedge fund database. Which obviously is very large and growing. And they use those to really make the best informed decision that they can have on allocations that they want to make are critical analysis of investments they have made. And if they're happy with those and if those are keeping pace with what the overall industry is doing, that's really what I would say about how the business is operating.
- [15:19]
Bill Kelly
Number of indices today inside of HFR?
- [15:23]
Kenneth Hines
Yeah, we're over 500 indices and continue launching new ones as the industry evolves. Like I said, we're very excited about the launches we've had in 2024, and we have more planned for 2025.
- [15:34]
Bill Kelly
Wow. So to some of the listeners, it might sound like a big number to say who needs 500 different indices? And they may not be all in the hedge fund space, but are there subcomponents as to how you would break down that 500?
- [15:46]
Kenneth Hines
Yeah, we have 11 different families of indices. And the reality is we have 500 indices, but to each investor really only needs one, but not everybody needs the same one. And so if you want an index of all regions and all strategies and all of everything and you only need one index, well, here it is. There's different weighting conventions as well. Some are equally weighted, some are asset weighted, some are denominated in different currencies. And so every index, everybody might only need one or two, but depending on who they are, they might need something different than somebody else. And so some people prefer to have strategy indices rather than composites of all types of funds. And so it really depends specifically on the investor and what they need. Another thing that I'll add, Bill, is that we do a tremendous amount of custom index business as well, where people want a benchmark that has certain characteristics as well. We do that all the time for people. A lot of our institutional clients have specific mandates where they invest in this or they don't invest in that. And we work with our clients all the time on custom indices as well.
- [17:00]
Bill Kelly
And that might be a good segue back to the pod shop index. So was that a custom index by somebody specifically that asked for it, or is this something created by HFR for the community?
- [17:10]
Kenneth Hines
No, that was just created by us. It's just really, I think, capturing an evolution of the industry and the way this has accelerated. There's always been multi strategy indices in the hedge fund industry, but I think that concept really took a leap forward in the last few years for a few reasons. And more and more an emphasis on pods, that with a multi strategy, there's some I Think overlapping portfolio management qualities and the idea that you have different portfolios of the same fund, but you can have the same portfolio managers and they can be located at the same place. The pot shop index really moves that a step further where the pods really don't know very much about each other at all. They might know almost nothing about each other. All that they're doing is trading their strategy, which the overall fund has decided to allocate capital to, and they can increase that capital or decrease it. And that's really the way that they work. The pods, especially the larger ones, there's so many of them, the expectation that they know each other or know anything about what the other one's doing. They're very much autonomous. And that allows risk management to be dialed up or down at the parent company level. But the funds continue to execute on their strategies very much independently of others. So that's really, I think, what differentiates a traditional multi strategy from a pod shop.
- [18:51]
Bill Kelly
So with a multi strategy, clearly somebody hopefully is overseeing risk and risk management because ultimately investing is the management of risk. But if I think about a pod shop or a pod shop index, where, as you clearly point out, team A may not know, team B, how do you adjust for risk management either in real time at a pod shop entity or when you create an index? Because you could have an overlap of index, you could be doubling down or have blind spots that nobody knows about. Do you try to adjust for that? In the index creation itself, index is.
- [19:28]
Kenneth Hines
Really just taking the performance of the funds that are reported to us. I mean, as part of the methodology, we certainly follow a very robust methodology, which is very important, but we don't adjust or risk manage these things. We just adhere to a methodology. And that means that we obviously spend a lot of time looking at the data that's provided to us and validated and looking for outliers or things that are unusual about it. But in terms of risk management that you're talking about, I think that that's really something that if you look at the industry over a long time frame, 20 years, 25 years, you talk about going back to the beginning of hfr, that's really something that has evolved significantly from the era of black box. Send in your money and you make 40% a year. Send us your money, you have no idea what's going on, but you're making 40% a year. Those type of scenarios to really knowing who's the portfolio manager and what are people investing in and how much leverage is being applied and what's the performance and how much capital. All these questions that investors now have answers to go back to the very beginning. There was a lot of black boxness about what people were doing in the late 80s and early 90s. And obviously as the institutionalization has progressed, it's become a very transparent industry and it really allows empowers the investor to make educated decisions on how they're allocating capital and what kind of risk they're taking when they're making those allocations.
- [21:09]
Bill Kelly
Makes sense. So jumping back to the 500 indices, as you just mentioned a moment ago, Ken, some of them are highly customized for a very specific client need, and that's pretty clear. But if I go to the other end of the spectrum, maybe the more garden variety offering that somebody would expect, given what they know about your model. I assume you have one for equity hedge funds and event driven hedge funds that shows the median return on your universe for any given time period, month, quarter, over multi years.
- [21:37]
Kenneth Hines
Yeah, I think one of the hallmarks of HFR's existence is really the taxonomy of hedge fund strategies. That's something that we developed and refined years ago. And that architecture which essentially has all hedge fund strategies of which we have around 30, that really flow into four main strategies, equity hedge, event driven, macro and relative value arbitrage. And then those obviously flow up to the composite that includes all strategies. So listeners, I mean most of them probably have visited our website. Certainly people that are taking your CAIA exams and studying for it on hedge fund strategies have probably gotten familiar with it. And every fund that contributes information to the database to be included in the indices is really categorized along those lines. And we call those the basis of indexation, meaning that the sub strategy, the strategy, the regional investment focus, if they have a country investment focus, all become the things that we extract out when we create indices. And it's real important for the listeners to know there's a number of important trends, just as it pertains to indexation that HFR has done considerable work on. First off, all the indices are designed to be investable, which means you could run a tracking product. And we operate tracking products and we license the creation of tracking products to institutions that want to create tracking funds. So that's useful to know. Even if you don't want to invest in a tracking fund, to know that one exists certainly does give a lot of credibility to the indices in terms of the performances recorded. In addition, there's two really important things that the listeners should know about. One is that we're compliant with a business best Practices for index providers called Iosco. Iosco is something that really came out of the LIBOR reporting scandal where people were just submitting crazy things to the LIBOR inquiries that they received and they were making up information. IASCO is essentially a best practices for index providers that's really designed to eliminate or mitigate that risk, I guess you could say. And the most tangible thing that that means to the users of our indices, and we're audited annually for our compliance with this most tangible thing to users of our indices, is that every year in writing, the managers that submit information to HFR have to agree to a code of conduct. Essentially means they stand behind the information that they provide to hfr, which is an important thing to know and obviously puts our indices on a track that investors can be confident in the information that they're looking at. And then the third thing is that the financial indices are becoming a regulated business in Europe right now. We're compliant with something called European Benchmark Regulation. We've been compliant with this for a number of years ahead of it being required right now, it's optional. Next year it's going to be mandatory. So that's a very significant thing. Indices that are not compliant with benchmark regulation will not be permissible financial indices once this is required next year. So this is a very significant thing. And all three of those things, investability, compliance with Iosco, compliant with European Benchmark regulations are all things that HFR has done to really make the indices the most useful benchmarks that they can be for our institutional clients all over the world.
- [25:30]
Bill Kelly
Well, great credit to you because I assume there's a fair amount of cost and labor attached to those efforts and doing it even before it was required is the hallmark of a quality product. So well done on that. So you had mentioned just a moment ago, Ken, that some of these indices, they are investable or maybe more appropriately replicated, but if it's replicated through another manager, that starts to at least sound like a higher fee, maybe more alpha based product. And I've often said that if somebody could create the vanguard of alternative investments, they should get a Nobel Peace Prize. Where if I could find your index for one or two basis points and just get access to the beta, that's uncorrelated for the less sophisticated investor, that is an absolute home run. But when you talk about replication, it's probably a manager that's trying to either track or beat that index and it starts to sound probably more like a 2 and 20 product as opposed to one or two basis points, it's not.
- [26:32]
Kenneth Hines
A 2 and 20 product at all. Obviously there's a number of different ways that this can be done. There are synthetic replication options for our indices and there are physical replication and I think, to use your words, they're really trying to deliver the beta of the industry and to track the performance of the indices. So synthetic replication, which can also be referred to as factor based, can use liquid regressions, financial regressions and things like this to replicate the performance of the industries. And then there's physical replication. There's actually creating a tracker fund that allocates to the constituents of the indices in an effort to deliver the performance of the indices by essentially having an S P style. Just like you can invest in the S P 500 futures contract and get the performance of the underlying 500 stocks, that the investable index operates the same way. And we've had that for a number of years. We continue to see growth in that area.
- [27:39]
Bill Kelly
So a couple areas I want to touch upon before we close, but maybe sticking slightly with the tactical before we get into your outlook on regulation, democratization, future trends and research. In the course of my travels, and probably yours too, Ken, I talked to a lot of emerging managers. Very talented individuals, very passionate about what they do. As best I could tell, they have a pretty thorough and thoughtful strategy. Maybe their bench is not as deep as maybe a billion dollar hedge fund manager, but if I'm thinking about sourcing alpha pockets of inefficiency and being able to play in the smaller space, all things being equal, I would think is a bit of an advantage. How difficult is it for an emerging manager to establish street cred? And I don't know if that's 100 million or more now. And what advice would you give them beyond, well, just pack it up, you don't stand a chance. But if that's the answer, they should hear that from somebody like you, as.
- [28:38]
Kenneth Hines
I think that's definitely not the answer. It certainly can launch a fund and grow a fund. It's not to say that it's easy and there isn't challenges associated with it, but you generate strong performance, you market aggressively to investors, and I think you come to know there's a lot of opportunity in this day and age to get in front of investors and tell them your story. I mean, most funds come out of portfolio managers at another fund or a bank or another trading entity and they can typically start with some capital from that entity. And it does take some time and effort to get to the requisite amount of capital. A lot of people will say 100 million or 200 million. We don't look at anything below that. Just because an investor that wants to allocate $20 million or $50 million can't do that. They can't be more than X percent of capital of a guy that's managing less than $50 million. So it does take some time to get to the scale where you can be considered for investors really. And that just comes from an element of risk control on the part of investors. You have to have enough capital that they're not going to be more than x percent of the capital. And the numbers can vary from person to person. But that's also sort of a sliding scale. The most institutional investors are going to have the highest limits and the lowest percent of. We don't want to be more than this amount of capital. But I think as the industry landscape has evolved, there's a lot of smaller to mid sized players that are willing to look at smaller funds and willing to invest in smaller funds. Yeah, there's a lot of them out there, but there's a lot of opportunity to meet these people. And people are definitely interested in an exciting, innovative story. I mean, there's so much now going on with. I don't mean just now like this week, I mean now the last couple of years. There's so many exciting areas, especially in the crypto space is one for sure. And there's other areas as well where there's exciting innovations that a traditional fund or a very large fund might not have the same, I guess you could say expertise or innovations that you can get from a smaller startup fund and that can create some really exciting opportunities that can be very appealing to investors. And so yeah, I definitely encourage smaller managers to. Obviously HFR is one great way to get your fund in front of investors for sure. There's others as well and there's great opportunities to meet with these. But you can do it. I know a lot of people that have grown funds from starting at 25 million or 50 million and they're managing billions of dollars now. So it definitely can be done.
- [31:38]
Bill Kelly
So does HFR have an Emerging Managers index?
- [31:42]
Kenneth Hines
We don't write at this moment, but we're pretty inclusive about the managers in terms of getting into the HFR500. So that's really the way that an investor can come to us and get included in the index and be sort of recognized as a fund in the industry relatively early on in their life cycle. And that's what we think is really beneficial to a lot of the funds and the reason that they begin reporting to us is that recognition of being included in the indices.
- [32:15]
Bill Kelly
Well, depending how many emerging managers are listening, maybe you'll be swapped with the requests and there'll be a home for a 501st index in emerging managers. So I'll leave it at that. So in the remaining minutes, just outlook on a few things and trends or emerging asset classes. And you mentioned crypto a moment ago. And where does that stand as an investable asset class? Bitcoin, over a trillion dollars. I think it eclipsed 80,000 a unit just this week and maybe even higher. But not only cryptos, but digital assets as well.
- [32:46]
Kenneth Hines
Yeah. And I think we're going through a period where there's a tremendous amount of innovation and disruption in all of the areas of decentralized finance. And the funny thing is, I want to say this is new or exploded recently, but to be honest, Bill, we launched our first index of crypto. I think it was December of 2017. So that's seven years ago. And it wasn't even brand new then. It's really been with us for the better part of a decade. I think interest has exploded recently and you're seeing this along a few different ways. You're seeing innovative new strategies that hedge funds are implementing. And this kind of comes back to your earlier comment about startups. It may be easier for somebody to start up a new trading idea in crypto at a new fund rather than at a big established one. And I think that that's really where people are definitely interested in hearing a story and exciting new innovation in that space for sure. And that's not going to be gone in a year. I mean, obviously a big development in the last year has been these listed ETFs that have been approved about a year ago. I think they've seen $25 billion or something going and there's been a tremendous amount of interest. And these are just funds that are offering beta access to Bitcoin or Ethereum, things like this. It's going to continue to grow and expand. And that's really where I think this create exciting opportunities for new managers.
- [34:29]
Bill Kelly
And I think particularly to spot Bitcoin ETFs. But then tied to that, the fact that you now have an actively traded futures market with Ethereum and Bitcoin, where you've got great transparency, the custodian issue has been sort of taken off the table. So there are ways of getting exposure on a pretty transparent basis. So I agree with you, that's a.
- [34:48]
Kenneth Hines
Big risk factor that's gotten taken away and certainly we'll see how things go. But the incoming administration has been very clear on their interest in creation of a strategic reserve and making the US the crypto capital of the world and all of these things. I mean, there's some very aggressive goals that are being put forth. And I think that the industry is going to continue to. I wouldn't say. I would say lead those trends in the direction of where those are going. You're going to see funds launching in the next couple of years that are doing more exciting things in the space all the time. And I see it every day. And obviously our clients can see it every day too. It's really just a fascinating period of disruption and we're right in the middle of it right now.
- [35:42]
Bill Kelly
Yeah. And if I look at this next administration and it is just four years, but four years used to be more than a full market cycle. I don't know if that's true anymore. But I think we're back in an era of less regulation. There was a great trade that I think many hedge funds put on and profited from around energy transition. And depending on which side of the trade you on, you did quite well. That might be arbitraged away. But if I take a step back and your remarks on digital assets and crypto, I would think if the answer had to be more or less, and I said, what are your views on regulation in the short to medium term? I assume it would be less or more laissez faire specifically with regard to crypto or regulation more broadly of the hedge fund industry. Regulation across the spectrum. But maybe we could talk specifically on hedge funds. Yes.
- [36:30]
Kenneth Hines
Yeah. There's no question that the incoming administration sees value in free market capitalism. Free markets and deregulation and allowing businesses to grow and let financial markets drive innovation and growth rather than being saddled with. And that really cuts across all industries. There's certainly risks then they have to be managed. But I think that as far as the spectrum goes, allowing the markets, financial market capitalism, to drive that growth, be it in crypto or in energy or in broader areas of finance, clearly deregulation is the trend. And I think that's going to drive. It's going to drive a M and a cycle that I expect to be very strong in 2025. And then you're going to see that coming through in hedge funds that are focusing on things like special situations and event driven and activism and all those areas. The worst thing for those type of strategies is uncertainty about the future, not knowing Whether or not it's not a question of is XYZ as a company undervalued or overvalued. After you answer that question, then you have a question. You say, well, what's the possibility that somebody might come in and sort of change the rules of the game? That's a much harder level of analysis for the portfolio manager, the analyst to do to rather than look at the company and say, okay, assume a constant in terms of regulation and let's try to decide if this company is over or undervalued, is trying to say, okay, we've made that decision. But now let's wonder, is the government going to come in and change any of the rules of the game? That's a very difficult analysis and one that I think causes people to pull back from committing capital and it hampers innovation and growth when people are concerned about those things.
- [38:35]
Bill Kelly
Yep, I agree. So maybe last question, Ken, I know that you folks put out a lot of high quality research. You just did one on history of presidential elections in red and blue. And a very good report I would encourage the listeners to look at. But as you think about research going into 2025, is there anything that's at the top of your hit parade in terms of issues you think you're going to try to be relevant and have your voice heard around?
- [39:00]
Kenneth Hines
I'll just briefly comment on the report and then come back to sort of broader trends industry wide. We started with a very simple question with the report, which was, okay, we're heading into the political election. If we look historically, had the hedge fund industry done better under Democrats and Republicans, just making no other assumption other than just look at the year and call it that? And so we got an interesting result there. But then the more we analyze that and we kept asking better questions and we began to socialize this with our clients and say, you like this. What other kind of things would you be interested in seeing? We got a lot of tremendous feedback and usually that is where our most interesting analysis goes because we're dealing with the leading institutions and they're like, oh, that's really great, but what about this? So we started off with a simple question, better under Republicans or Democrats, and going back to the beginning, 1990, it's slightly better under Democrats. But then as you start to sort of peel back the onion, and again, we're not trying to change that conclusion, but really look at the assumptions that drive it and say, yeah, but let's think about what strategies do better. And here's an interesting trend. When you look at the strategies by term, your presidency 1, 2, 3 and 4. We found a really interesting phenomenon, that years 1 and 3 are great. No matter what assumption we make, year 2 is always the lowest performing year of the four, no matter how many different ways we cut it. And then I think there's some certain intuition behind that, meaning that you sort of come in and there's a lot of favorable momentum. But year two is when people kind of implement things that might take a little bit longer for the markets to see the value in those things. And then by year three, you're seeing strong performance. So over the entire 34 years of history, year two was categorically the lower year. But again, that was different under Democrat and Republicans. That was different under certain strategies than other strategies. So industry growth overall was slightly higher under Republicans. One of the ideas we had is let's take out the financial crisis of 2008. Obviously that happened in year eight of a Republican administration. But. And again, people, I'm not trying to say that it's not a political output or I'm not trying to say that. I'm just saying if you want to take that out and see what's the result. If I'm of the mindset that this is not a political thing, it was a financial crisis that was sort of independent of what administration was in the office, okay, you take that out and that totally changes the result. You actually have a higher annualized performance under Republican administrations than Democrat. And I'm not trying to say that anybody should or shouldn't remove that from their calculation. Obviously it is what it is, but it's just an interesting insight. And the whole report was designed to be a useful tool that our clients, portfolio managers, can use when they're thinking about what strategies should I be overweighting or underweighting and what year. And based on gridlock, we analyze the gridlock between the houses of Congress, gridlock between Congress and the President, all of those things. So I encourage everyone to look at. It was really a fascinating process of thinking about what questions would be interesting and answering them with the data that we have. And so it was a lot of fun. The reports on our website, it's free to download. So I encourage everybody that has any interest in just seeing how these trends evolve. It's really been a fascinating thing over the last month or so of putting this together.
- [42:36]
Bill Kelly
I looked at it too. Just one quick observation that I want to talk about the future. So what's going to be very interesting to see though? And saying this time is different is always fraught with peril. But I've never seen, I don't know what the opposite word of gridlock is. Maybe it's Greece. The alignment of the White House, the House, the Senate, the Supreme Court, the Fed and the primary regulator. We've never seen such unison of control like we're going to see going forward. And it's going to be very interesting to see how this plays out. But we have to remain fully invested.
- [43:07]
Kenneth Hines
It's funny, I had always heard, not specific to the hedge fund industry, specific to the equity markets, that gridlock was better for the markets. People said that if Congress and the President are in different houses, that the S and P does better because there's less likelihood of a change that people don't agree with. And again, I've never seen that proven, but that's just conventional. But our research actually shows the opposite, that when both houses of Congress are the same party, the HFRI is better than when they're split. And when the President and Congress are of the same party, they do better than when they're split. And again, this is some of the interesting things that come out of doing this is you actually see these results play out in the data that we put out. So it's really fascinating stuff. I encourage people to have a look at it.
- [43:56]
Bill Kelly
Okay, so themes for 2025.
- [43:59]
Kenneth Hines
Yeah, absolutely. I mean, we've spent the last, I would say 18 months, the world's been dominated by a combination, more so a year ago, generational inflation and absolutely generational geopolitical risk. Not just elections in the U.S. but the military conflicts and the prospect of additional military conflicts and all the impact that that uncertainty has had on investing and hedge fund strategies. For sure. I mean, it's been a very, very challenging period with these conflicts coming up and the election, obviously, most recently with the US but the last year we've had European elections and some have swung far right and some have swung far left. It's not even a consistent theme to say that they all went one way, which is kind of fascinating in and of itself. But as you look at 2025, you have to expect that deregulation, for sure, across industries, not just finance, across, I think a more supportive administration for evolution of the crypto industry, certainly deregulation of the energy industry and other industries. I mean, I'm very confident that we're entering into a strong year for 2025. But I think that to come back to my earlier comment, for the first time in a long time, inflation pressures have subsided and more recently, the geopolitical uncertainty has subsided. People may still not be 100% clear on, and I think they're getting more clear by the day of what the policies of the new administration are going to be. But we have a fair idea on a lot of them, more so than we had a week and a half ago. And that, I think, going all the way back to 2020. In the beginning of the quarantine, you had a period where businesses were sort of frozen in terms of making strategic decisions very much at that time. You go from the quarantine where everything's shut down for a year and a half to two years. Coming out of that, you have generational inflation. These have been very difficult times to navigate a business environment. And then you come straight out of that into an environment of spiral generational geopolitical risk. And then as you look at 2025, my expectation is all three of those risks are going to decline. They're not going to go away entirely, but they're going to. We could see inflation come back. We could see continuing geopolitical conflict. We still are figuring out what the new administration's policies, and the same thing with European elections, but expectations for 2025 versus the last two years and the last five years of uncertainty. When you factor in the quarantine and inflation and interest rates and all that stuff, expecting 2025 to be a strong year with a lot of those risks lower, then you think about hedge fund strategies and what's likely to do well? Well, I think most strategies are likely to do well. I would think that event driven, certainly with an emphasis on M and A and special situations, and shareholder activists are very well positioned in this environment. But everything that I'm talking about is supportive and accretive to the performance of all hedge fund strategies. Equity hedge should do well. Relative value. It's not clear that interest rates are going to be higher or lower a year from now than what they are right now, or that inflation isn't going to. There's a tension there about whether it's going to be higher or lower relative value. And then macro strategies, I mean, they're doing well recently. It can be cyclical, it can be related to a lot of different trends. They're uncorrelated. But the outlook for all these strategies is extremely constructive. And so I think it's going to be an exciting year. Bill?
- [48:01]
Bill Kelly
Well, I think the common denominator is we're always allocating in various seasons of uncertainty, and some of them are more violent than others. And as investors, we have to be both strategic and tactical as well. And you gave us a lot to think about, Ken. And and I'll finish where I started, which is thanking you for your friendship and partnership and bringing greater transparency to a part of the industry that I think is oftentimes misunderstood and maybe underbought for the value it can add. And I think this is a great discussion. So thanks again for joining me.
- [48:32]
Kenneth Hines
Thanks for having us on, Bill, and happy to come on anytime and talk about the trends that we're seeing.
- [48:37]
Bill Kelly
Excellent. Thanks. Thank you for listening into Educational Alpha. I'm your host, Bill Kelly. Learn more about the Kaya association and subscribe to the show at kaya.org. that's C A IA.org. see you next time.