Harry Rady Online – San Diego, CA

The following article was written by Harry Rady and originally appeared in the 19-25  March, 2009 issue of HFMWeek.com.

Let’s face it, the last six months have been miserable for investors, and even good investment managers haven’t slept well recently. But, investors have learned much over the past year, and many now realize there is often an unnoticed, inherent conflict of interest between investor and money manager.

“What has become all too common is for managers to perform in line with an index or to experience wild swings. This is an incomplete strategy”

When times are good and the market is moving up at a steady pace, investors tend to become complacent and ignore many potential risks. When the market, however, turns down and things get tough, investors get scared and start to ask the questions they should have asked long before making their investment decisions.

To at least ensure greater protection moving forward, investors need to start asking a very key question: “Do you (the investment manager and/or employees) have the majority of your net worth invested in the fund where you want me to put my money?” The answer, of course should be “yes”. Investors want and need to be in the same entity that the manager is using to calculate his/her composite returns.

Most managers who have had solid performance – and believe in their future risk-adjusted return prospects – will have most of their own money in the fund that the investor is considering. This shows a commitment to the investment strategy and also makes sure the manager feels the “pinch” along with investors when times are tough. It also demonstrates a greater focus on risk management, as opposed to always swinging for the fences.

Another potential benefit of this “alignment of interests” strategy is the incentive for the manager to focus on the tax consequences of trading and turnover ratios. For investors, it is after-0tax returns that really matter.

Another key metric for investors, which will give them a clear understanding of whether the manager has the shareholders best interests in mind is the upside/downside “capture” ratio. This ratio lets investors know how much real risk the manager is taking to generate returns. The higher the upside capture – the greater their returns; the lower the downside capture -  the lower the losses and risk.

Ideally, investors want to look for a combination of low downside capture along with high upside capture. The ratio gives the investor a powerful historical understanding of a fund’s risk/reward profile. Investors should look at at these metrics in the context of prior periods to see how they performed in different market environments.

What has become all to common is for managers to perform in line with an index or to experience wild swings. When markets are good, they outperform; when the markets turn negative they substantially under-perform.  This is an incomplete strategy. The focus should be on asymmetric risk/reward ratios in every type of investment. The best opportunities exist when securities are ignored or investors are too pessimistic about their potential. Some of the most viable investment opportunities exist when funds are able to purchase securities ignored by most investors.

The idea of following the herd and chasing returns always catches up with managers and their investors. If anything, we’re seeing that it pays to be a contrarian. A contrarian approach leads to attractive upside/downside capture ratios, which again, is an effective way to demonstrate risk adjusted returns.

Finally, it is also important for a manager to have a long term track record. This lets an investor know that the have experienced different market cycles and are not just getting lucky at a particular time in the cycle. In addition, the investment strategy must be transparent, easy to understand and repeatable. Most investors should not invest in highly levered, esoteric strategies unless they are truly disposable assets.

A core portfolio needs to offer the potential for consistent returns and must have the flexibility to be both long and short during volatile periods, giving managers the flexibility to protect the portfolio, while still capturing the upside.

Protecting the portfolio, of course, is key. Unfortunately, many investors have been learning that lesson the hard way. Moving forward, it’s abundantly clear that the unnoticed conflict between the money manager and the investor can no longer exist. And by the way, ask the manager if he’s getting a good night’s sleep.

Harry Rady is CEO and portfolio manager of Rady Asset Management, a long/short equity fund based in San Diego, CA.

Citigroup said it operated at a profit during the first two months of the year. That energized financial stocks and in turn, the entire market. Surprised investors drove the major indexes up more than 5.5 per cent to their biggest one-day rally of the year. The Dow Jones industrials shot up nearly 380 points.

In response to Wall Street’s welcome upturn at the beginning of March,  Harry Rady of Rady Assets Management, San Diego, California was quoted as saying:

A little bit of good news went a long way because there was so much pessimism,” said Harry Rady, chief executive of Rady Asset Management. “Could there be follow through tomorrow? Maybe. In the next few weeks or months I’ve got to imagine we’ll give this back. The economy is in an absolute free fall,” he said. “I’d be very surprised if this was a bottom.

On March 10th the S&P 500 index rose 43.07, or 6.4 per cent, to 719.60, while the Nasdaq composite rose 89.64, or 7.1 per cent, to 1,358.28.

Most analysts are cautiously optimistic and are waiting to see which way Wall Street is heading in the upcoming near future though there is a worry that hundreds of billions of dollars in government bailouts wouldn’t be enough to save the big banks.

This upturn was described as a brief rally in an overall bear market, meaning that we can expect more market downturns before the market begins its eventual recovery. A bear market is defined as a drop of at least 20% from a market high, which stocks passed last year in their relentless plunge downward.  Now the market is at less than half its value that it had at the highest points it reached in October of 1997.
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MarketWatch.com reports on the general markets and the developments affecting  the shares and share prices. There was much debate about General Motors Corp. whose shares climbed 2% as to whether the government should take action to prevent the automaker from possible bankruptcy.

” The free market should determine who makes the best cars, and the consumers should determine who survives,” said Harry Rady, CEO of Rady Asset Management.
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Founded in 1954, Rady Children’s Hospital and Health Center states its mission being “to restore, sustain and enhance the health and developmental potential of children” achieving this “through excellence in care, education, research and advocacy.”

Rady Children Hospital & Health Center is the regional pediatric medical center serving San Diego, and Imperial & south Riverside counties. Each year the Children’s Hospital cares for approximately 100,000 children who are provided medical care (both at the main campus or at one of its 28 satellite facilities).