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

Episode Summary

Executive Summary: Adam Blitz explains how Evanston Capital builds a hedge fund-of-funds portfolio by prioritizing manager skill, passion, and sustainability of edge over top-down market calls. He argues the average hedge fund adds little net of fees, but exceptional specialists—especially in long/short equity and selective volatility trades—can still deliver strong risk-adjusted returns, particularly as passive investing and low volatility create more dispersion and opportunity.

Main Topics: Evolution of the hedge fund industry (Priority: 5/5): Blitz contrasts the hedge fund category in 2002—seen as a source of elite talent and absolute return—with today’s more institutional, risk-mitigation-oriented market where average performance has disappointed and the industry’s value proposition has weakened. Evanston’s bottom-up manager selection philosophy (Priority: 5/5): He emphasizes that Evanston looks first for durable skill, passion, and a repeatable edge in individual managers rather than starting with strategic asset allocation or macro views. Portfolio construction and strategy mix (Priority: 5/5): Evanston builds a diversified portfolio with a relatively high allocation to long/short equity, plus event-driven, macro, and relative value, while avoiding heavy leverage and crowded trades because of liquidity risk. Manager sourcing, diligence, and decision-making (Priority: 4/5): The firm sees over 200 new managers a year, relies on referrals from current managers and trusted networks, and uses a unanimous nine-person investment committee to avoid weak conviction and groupthink. Monitoring and behavioral red flags (Priority: 4/5): Ongoing oversight focuses on soft factors such as cultural drift, morale, asset growth, and manager passion, not just monthly performance or exposure changes; the firm is alert to sleaze, style drift, and liquidity mismatches. Future opportunities in hedge funds (Priority: 4/5): Blitz is constructive on skilled long/short equity managers benefiting from passive flows and on long-volatility strategies, arguing low volatility and market distortions create mispricings that skilled managers can exploit.

Key Arguments: The average hedge fund manager likely adds little or no value net of fees, so the key is identifying the rare manager with true, sustainable skill. Long/short equity can be more diversifying than commonly believed because different sector specialists derive alpha from different sources over multi-year periods. Manager selection should be mostly bottom-up; forcing mediocre managers into a top-down asset-allocation bucket creates more errors than it solves. High leverage and illiquidity are unattractive because they can turn mark-to-market losses into permanent losses through redemptions or margin calls. Qualitative factors—passion, competitiveness, joy in the work, and honesty—are crucial predictors of staying power and future success. A unanimous investment committee helps prevent groupthink and ensures only high-conviction ideas make it into the portfolio. Asset growth is a major monitoring concern because it can trigger style drift and degrade performance. Low volatility and passive flows create opportunities for excellent long/short equity managers because fundamentals and prices are increasingly disconnected. Long volatility is attractive at current low levels, but equity vol carries negative carry; interest-rate and currency vol can be more efficient expressions of the view. The next major performance regime will be important for hedge funds’ credibility: if markets struggle and hedge funds hold up, demand could revive; if not, capital may continue to leave the category.

Data Points: Firm AUM: just south of $5 billion - Evanston Capital Management portfolio size mentioned in the introduction Industry scan / meetings: north of 200 new managers per year - Annual number of new managers Evanston meets Investment committee size: 9 members - Formal investment body requiring unanimity for new investments Approval requirement: unanimous approval - All nine committee members must approve a manager to enter the portfolio Turnover: 15% to 20% per year - Average portfolio manager turnover Long/short equity exposure: 40% to 50% net exposure - Typical net exposure across Evanston’s long/short equity universe Firm strategy mix: ~50% long/short equity, ~15% macro, ~20% event-driven, remainder relative value - Approximate portfolio allocation across strategies Consensus long/short equity allocation: 30% to 40% - Blitz’s estimate of a typical hedge fund portfolio’s allocation to long/short equity Realized S&P volatility: about 7% - Recent realized volatility level cited as unusually low Volatility regime: lowest decile vs. history - Volatility across currencies and rates described as historically very low Hedge fund history: 2002 inception - Evanston began in 2002 Industry perspective timeline: 15+ years - Length of Adam Blitz’s hedge fund portfolio management experience Career starting point: Goldman Sachs and AQR - Early roles that shaped his investing framework

Pivotal Quotes: "The average manager isn't very interesting." — Adam Blitz: On why most hedge funds likely add little value net of fees "We actually think long short equity is the strategy where you get the most diversification among underlying managers." — Adam Blitz: On Evanston’s counterintuitive portfolio-construction view "We have a term we just call sleaze factor." — Adam Blitz: On the soft-factor red flag that can cause Evanston to walk away from a manager

Implications: The episode suggests hedge funds remain valuable only when investors can consistently identify true edge, manage liquidity, and avoid crowding. Passive flows and low volatility may widen opportunities for a small elite, but the average manager still looks unattractive.