Wealth Manager Profile: Michael Azlen on why most hedge fund investors are overpaying

Frontier Capital Management’s Michael Azlen is something of rare breed, turning his back on the lucrative fund of hedge funds world because he believed investors were getting a bum deal.

The Canadian headed up US alternative investment manager Asset Alliance’s London office until 2003 when he became disillusioned with hedge fund land.

‘Our industry is built around alpha and I was in the highest alpha area of all – hedge funds and their uncorrelated returns and real alpha,’ he recalls. ‘However, after 20 years in the industry, my view was that it is best at thinking up innovative ways of extracting fees from clients.’

Research he commissioned into the group’s flagship fund was what made his mind up to quit and strike out on his own.

‘The fund of hedge funds invested in 35 single-manager hedge funds and in 2003 I was becoming increasingly concerned that the underlying managers were exhibiting more and more beta in their return streams,’ he says.

‘I hired a quants analyst and studied the return stream and broke down just how much was related to market factors and how much was actual alpha.

‘The results shocked me. They indicated that 75% of returns were related to six exogenous beta factors, such as stock or bond markets, currency and spreads and so on. The other 25% was unexplained; the industry would tell you that that is alpha but now it is called exotic beta.’

Azlen says he found this very dispiriting, particularly given that his clients were typically paying 2% annual management charges (AMCs) on the underlying holdings and a 20% performance fee, while Asset Alliance levied a further 1% AMC and 10% performance fee on top of that.

Explaining this to the group’s investment committee won Azlen few friends, perhaps unsurprisingly. ‘We were charging three and 30, but the return stream was being produced by beta,’ he says in near disbelief. ‘I sat on the investment committee and presented the regression analysis but it gained no traction because no-one wanted to admit that to clients.’

With the view that passive investment, capturing market returns with minimal cost, was the way forward, he launched Frontier in 2004.