The Little Book of Hedge Funds

Chapter Eight

If You Can’t Beat ’Em, Join ’Em

Hedge Fund Manager Selection and Due Diligence

In evaluating people, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you.

—Warren Buffett

Throughout this book I have been stressing the key differences between hedge funds and other asset classes. In an effort to generate absolute returns and produce alpha, a hedge fund manager must possess the uncanny ability to fundamentally select the best stocks and systematically diversify his portfolio so that he can produce risk-adjusted returns. But for every stock-picking guru like David Einhorn or Dan Loeb there are dozens of other nameless hedge fund managers who are not quite as successful.

Although the purpose of this book is not to uncover the secret formula for achieving alpha-like return, nor is it to explain in painstaking detail how to invest in hedge funds, this chapter will spend a bit of time showing you how investors and fund of hedge fund managers screen the over 9,000 hedge funds that are currently in operation.

The core to this hedge fund investment process is:

• Manager Selection
• Portfolio Construction

As hedge fund managers are like snowflakes with no two being alike, they all have very different pedigrees, philosophies, processes, strategies, track records, and personalities—all of which is important to assess when making an allocation decision. Although the discovery, evaluation, and monitoring processes ...