Sunday Strategist: A Hedge Fund Willing to Share the Downside

(Bloomberg Businessweek) -- A fascinating hedge-fund experiment is underway in Singapore.

Vulpes Investment Management set up a new fund in which it promised to absorb the first 2% of any loss. Instead of a standard 2% management fee, it will charge just .75%. Meanwhile, investors can further limit their downside (and upside) by identifying in advance as risk-averse.

The structure is complicated but artful. It essentially lets investors choose their level of risk and reward, not unlike a synthetic security maker slicing up a package of loans in tranches. Hedge-fund investors do this already by spreading their holdings; at Vulpes, they can do it in one place.

As for taking some of the down-side risk, it’s surprising investment shops don’t do it more often. There’s a catalogue of evidence that shows all but the most rational performers suffer from loss aversion: the pain of losing a dollar outweighs the pleasure in gaining one, by roughly twice as much. Vulpes promises to absorb the first 2% of a loss, psychologically, is equivalent to guaranteeing a 4% gain.

Vulpes's upside, meanwhile, tops out at 25 percent of gains, higher than the industry’s standard 20 percent take. At the very least, the novel structure is good marketing, which hedge funds are struggling with of late. Investors have collectively yanked $116 billion from the sector since 2015. “We need experimentation because the status quo is failing,” Vulpes founder Stephen Diggle told Bloomberg Businessweek.

Similar thinking has already spread to other industries. It's taken four decades but strategists are slowly building price and product structures that leverage loss aversion. This is why grocery stores are charging for plastic grocery bags (rather than rewarding customers who bring their own). It’s also why a small upcharge for travel insurance works better than selling a more expensive, flexible airline ticket; the customer is focused on the potential loss not the gain of convenience.

Retail, with free shipping and returns, is arguably the paragon. Once the transaction is done, sending the product back feels more like a loss than a gain, albeit only slightly.

If it works for Amazon.com, it might work for the hedge fund set.

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To contact the editor responsible for this story: Silvia Killingsworth at skillingswo2@bloomberg.net

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