Adam Blitz – Inside Hedge Fund Allocation (Capital Allocators, EP.17)

Episode Summary

Executive Summary: Adam Blitz describes how Evanston Capital selects and monitors hedge fund managers, emphasizing bottom-up manager selection, deep qualitative judgment, and portfolio construction built around skill, liquidity, and diversification. He argues the average hedge fund adds little net of fees, but a small subset can still deliver strong risk-adjusted returns, especially in long/short equity and volatility strategies.

Main Topics: The evolution of hedge funds (Priority: 5/5): Blitz explains how hedge funds shifted from being viewed primarily as return-enhancing access to exceptional talent into a more institutionalized tool for diversification and risk mitigation. Bottom-up manager selection (Priority: 5/5): Evanston starts with individual manager skill, passion, and repeatable edge rather than top-down strategy bets, then sizes exposures through portfolio construction. Strategy preferences and sourcing edge (Priority: 5/5): The firm favors smaller, sector-specialized long/short equity managers, larger distressed managers with infrastructure, and differentiated macro/relative value investors with sustainable edge. Risk management and liquidity (Priority: 5/5): Blitz stresses tolerance for mark-to-market volatility but low tolerance for permanent loss driven by leverage, redemptions, crowded trades, and illiquidity. Qualitative judgment in manager evaluation (Priority: 4/5): Beyond track record and operational checks, Evanston places heavy weight on soft factors like passion, integrity, culture, and what Blitz calls the 'sleaze factor.' Current opportunities in markets (Priority: 4/5): He sees long/short equity and long-volatility strategies as especially attractive given passive flows, low realized volatility, and market distortions. Industry outlook and hedge fund role (Priority: 4/5): Blitz believes hedge funds need the next performance cycle to validate their role, but the best managers should still outperform in a more volatile or dislocated environment.

Key Arguments: The average hedge fund does not add much value net of fees, so the portfolio must be built around a small set of truly skilled managers. Long/short equity is best sourced through sector specialists, especially smaller firms with deep expertise and less capital. Distressed debt requires larger, well-resourced managers with legal infrastructure and multi-cycle experience. Portfolio construction should be bottom-up, with risk controls used to avoid concentrated exposures rather than to force top-down bets. Quantitative risk metrics cover most scenarios, but qualitative judgment is needed for the tail events that matter most. Liquidity is a central risk because redemptions and leverage can convert temporary losses into permanent losses. Passively driven market flows should increase stock-price distortions, creating more alpha opportunities for top stock pickers. Low volatility across asset classes creates opportunity for long-volatility strategies, though the carry cost in equity vol can be painful. The best manager decisions depend on softer signals—passion, partnership, culture, and conviction—not just track record and process. Hedge funds will likely regain appeal if markets are difficult and funds perform well in that environment.

Data Points: Firm AUM: just south of $5 billion - Size of Evanston Capital Management's hedge fund-of-funds platform Number of managers invested with: about 30 - Approximate size of the manager portfolio despite a much larger hedge fund universe New managers met per year: north of 200 - Annual sourcing flow of prospective managers Investment committee size: 9-person committee - Formal investment body approving managers Approval threshold: unanimous approval - All nine committee members must approve a new manager Portfolio turnover: 15% to 20% annually - Typical rate of manager turnover in the portfolio Long/short equity net exposure: 40% to 50% - Typical net exposure range among long/short equity managers Consensus long/short equity allocation: 30% to 40% - Blitz's estimate of how a typical hedge fund portfolio is built Illustrative firm exposure: close to half in long/short equity - Evanston’s approximate overall allocation Macro exposure: about 15% - Approximate share of Evanston's portfolio in macro strategies Event-driven exposure: about 20% - Approximate share of Evanston's portfolio in event-driven strategies Realized S&P volatility: about 7% - Recent realized volatility cited as unusually low Cited market observation: lowest decile relative to history - Low volatility across currencies and interest rates

Pivotal Quotes: "We think quantitative measures of risk work in 98% of the cases, but it's the 2% of the other cases that you really need to worry about." — Adam Blitz: On why Evanston supplements quantitative risk with qualitative scenario analysis "We really want to think of these as long-term partnerships." — Adam Blitz: On manager monitoring and the importance of culture and trust "If we can't convince each other something's an interesting idea, it probably isn't an interesting idea." — Adam Blitz: On the firm's unanimous, collegial investment committee process

Implications: For allocators, the edge is in manager selection, not category labels. The best hedge fund portfolios will be smaller, more selective, liquidity-aware, and biased toward skilled specialists who can exploit dispersion and volatility.