Blind dedication to Loss Aversion secures AUM post made possible through and Neil Azous



The 2008 financial crisis exposed institutional money managers to a range of risks for which they were not prepared. Some of these were market risks, in which the value of their investments declined more than they had previously imagined possible. Some of these were liquidity risks, in which still-viable strategies gated their funds, thereby preventing investors from getting their money out. Finally, some of these were operational risks, in which the demise of Lehman Brothers and the Madoff scandal highlighted the importance of factors such as accounting, compliance, and infrastructure, as well as just performance when it came to choosing a fund.

In the wake of a traumatic loss, whether it is financial or personal, it is just human nature to overcompensate to make sure the experience is not repeated. But while that is understandable, it is rarely the best response. And so it has proved for many hedge fund investors over the past few years. While one could argue that each of the investor responses highlighted above has damaged investment performance, this article will focus on one specific issue:  the cult of loss aversion in global macro investing.

Although some global macro funds performed strongly during the financial crisis, others were caught up in the maelstrom.  As a result, while the strategy attracted strong inflows in 2009-2010, enthusiasm was tempered to a degree by the realization that an idiosyncratic macro investment would not automatically guarantee a hedge against generalized market stress. At the same time, the recipients of these inflows were keen to maintain their larger asset bases and the fees associated with them. This has become a particularly important factor over the last several years as conventional strategies have performed strongly, and with investors demanding positive returns in macro regardless of the underlying market and policy dynamics.

The result has been a concentration of assets under management (AUM) amongst a few very large funds, many of which fetishize loss avoidance over all other factors in trade selection and risk management. Of course, risk management is an important part of any robust investment process.  However, in modern macro investing the cult of loss aversion is becoming counterproductive given the fundamental and market outlook.

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