Biggest pension shunning hedge funds a green light for liquid alts

Biggest pension shunning hedge funds a green light for liquid alts:

"The California Public Employees' Retirement System, commonly known as Calpers, announced Monday it is eliminating its $4 billion exposure to hedge funds for reasons largely related to high fees."

In a related article on Main St, Hal Bundrick writes:

"“We are always examining the portfolio to ensure that we are efficiently and cost-effectively achieving our risk-adjusted return goals," Ted Eliopoulos, interim chief investment officer for the nearly $300 billion pension fund, said in a statement. "Hedge funds are certainly a viable strategy for some, but at the end of the day, when judged against their complexity, cost, and the lack of ability to scale at Calpers’s size, the ARS program is no longer warranted."

"http://www.mainstreet.com/article/if-smart-money-is-exiting-hedge-funds-why-are-you-still-hanging-on/page/2"

Still on the hedge fund band wagon?  Let's go over to the Fool.com where Morgan Housel wrote back in January: 

"...it's become plainly clear in recent years that the biggest bull market was in inflated promises. As a group, hedge funds -- which now manage $2.5 trillion -- have consistently underperformed a basic S&P 500 index fund over the last five years. 

Anyone want to predict hedge fund fees will keep falling?

Related articles

• Nation's Biggest Pension Fund to End Hedge Fund Investments
• With Calpers Quitting Hedge Funds, Other Investors Reflect
• Why Everyone Needs to Know About CalPERS Changes: An Interview With Mitch Tuchman
• CalPERS Cutting Hedge Fund Investments To Reduce Costs

Hedge Funds And S&P 500 Nearly Identical - Business Insider

Hedge Funds And S&P 500 Nearly Identical - Business Insider:

This one surprised me.  I was expecting the normal "Hedge funds don't outperform" article but this is much better.  It shows that hedge funds while not outperforming indexes, have (on average) had lower risks.

A look in:

" ...the path of achieving the 8.6% return would have been dramatically different between these two. The monthly return volatility for the S&P500 is nearly double that of the hedge fund index. And while the correlation between the two indices is almost 0.6, the beta of the hedge fund index has consistently been low - about 0.33 over the 20 year period."

I definitely recommend clicking through and seeing the charts.  They do tell a story that is often forgotten when only returns are considered.
Read more: http://www.businessinsider.com/hedge-funds-and-sp-500-nearly-identical-2013-8#ixzz2bltKrLgq

Are hedge fund investors beginning to relaize returns are not that great?

In some recent papers, researchers argue that the return from an investment mainly results from exposure to systematic risk factors. Jaeger, L., Wagner, C., “Factor Modelling and Benchmarking of Hedge Funds: Can passive investments in hedge fund strategies deliver?”, Journal of Alternative Investments (Winter 2005) (Photo credit: Wikipedia)

First the "what": Investors are redeeming hedge funds, especially equity funds:

Hedge fund investor inflows turn negative in March - preference for credit strategies continues - Opalesque:

"After a seven month span of consistent positive flows ending November 2012, during which MBS focused funds took in an estimated $6.1 billion, the group has seen outflows in three of the last four months. Despite having net positive investor flow during this time frame, it is of interest that the group’s flows are no longer universally positive....Investors again were net redeemers of assets from directional equity strategies in March. Q1 marked the seventh consecutive quarter of redemptions from equity strategies, matching the duration of outflows the group endured during/after the financial crisis."

The "why" is unknown, but one possibility is that investors are starting to see that just because a fund has the word "hedge" in it, does not mean it is a great fund.  Indeed, it may be far from that great.

To wit:

Rob Arnott: Why I've had it with hedge funds - The Term Sheet: Fortune's deals blogTerm Sheet:

"Arnott's colleagues started with a portfolio with a basic mix -- 60% stocks and 40% bonds. They then took a look at what would happen if the portfolio was shifted gradually, 10% at a time, into hedge funds. The result: Returns went down, and risk went up as the exposure to hedge funds increased, which is the opposite of what you want.

"Portfolio efficiency didn't improve," says RA's John West, author of the firm's hedge fund study. "In fact, it deteriorates with each additional allocation to hedge funds."

Hedge funds did a little better over the past 15 years. But even over that period, West found that a pension fund would have done better by adding a passively managed mix of commodities, real estate, and other assets, rather than expensive hedge funds."

And yet money flows into hedge funds.  What is the allure?  Maybe Statman is right and it is just that people want to brag (appear rich) and investing in hedge funds does that!

Related articles

• Job Security and Hedge Funds
• It's Never Been Harder To Start A Hedge Fund
• All that glitters does not lure - thoughts on DC default funds.
• Half of Hedge Funds Think Their Competitors Are Cheating
• Pity the Rich Investing in Hedge Funds. Seriously.

Hedge Funds are About to Undress

Image via WikipediaHedge Funds are About to Undress:

While we do not know the consequences of the new regulations, Oilprice.com is expecting a contraction in the hedge fund world as a result of the new rules"

"The July 21 deadline for the hedge funds to register required by the one year anniversary of the Dodd-Frank bill is fast approaching, and the industry is roiling with turmoil. The net result for the rest of us could be shrinking market liquidity and falling asset prices as hundreds of funds shut down or move overseas rather than meet the new, onerous disclosure requirements and the vastly increased legal liabilities they imply.

The new regulations raise the level of disclosure virtually to the same level already demanded by your garden variety, plain vanilla mutual fund. Details will have to be released about assets under management, performance, strategy, risk management procedures, custody, brokerage relationships, soft dollar arrangements, commission discounts and kickbacks, fees, compensation of the managers, types of clients, conflicts of interest, and of course, their largest holding. All of this information must be provided in plain English, filed with the SEC, where it will be available online to the public."

For a good "cheat sheet on the Dodd-Frank bill click here.

Related articles

• 2011: Disastrous Year For Mutual, Hedge Fund Managers (ritholtz.com)
• Why hedgies are lobbying for lower walls (blogs.ft.com)
• How to make money in hedge funds. [David Crozier] (ecademy.com)
• Hedge Funds May Attract $80 Billion in 2012, Barclays Says (businessweek.com)
• 40pc of hedge funds mislead investors, according to Oxford University study (telegraph.co.uk)

Video of the Trillion Dollar Bet in 5 parts

YouTube - The Black-Scholes Formula - 1/5:

The Trillion Dollar bet, which is based on the Long Term Capital Management story (when Genius Failed) , is a staple in my classes. Here is the first of 5 parts of the old PBS video.

HIGHLY recommended! The show is really two separate stories--on one on the history of the Black Scholes formula, and one on the Collapse of Long Term Capital Management.  (FWIW We  usually use the latter mainly in class but the whole thing is good!)






The moral of the story is that absolute adherence to quantitative models is what frequently gets you in trouble. Models are representations of reality and reality can often vary widely from the model.

Part 1, Part 2, Part 3,  Part 4, Part 5

Related articles

• Nobel Laureate Myron S. Scholes, PhD Shares Insight with IMCA (prweb.com)
• Myron Scholes on lessons learned (theglobeandmail.com)

Thanks to Zvi for the link (and reminding that I had promised to post this!)

Hedge Funds? Only if You Like Lots of Risk - You’re the Boss Blog - NYTimes.com

Great introductory (or even intermediate) article on Hedge Funds.

Hedge Funds? Only if You Like Lots of Risk - You’re the Boss Blog - NYTimes.com:

"Hedge funds are meant for people who know what they are doing, people accustomed to putting real money at risk. Federal law permits investment only by “accredited investors” — generally people with annual incomes of at least $200,000 for singles, $300,000 for couples, or at least $1 million in assets.

For investors who pass that hurdle, hedge funds offer opportunities you simply cannot get with mutual funds, whose activities are limited by federal rules meant to minimize risk for small investors. There are about 8,900 hedge funds, with total assets of $1.43 trillion at the end of June."

It goes on to talk about risks, strategies, and expenses.

Good article-will definitely use in class!

Study hints that alpha may be finite (at least in the short term)

Fascinating look (albeit not over a seriously long time frame) from AllAboutAlpha that is consistent with the long held economic view that if there are positive abnormal returns to be had (in financial or product markets), newcomers to market will drive down the returns (hence importance of barriers to entry etc).


AllAboutAlpha.com» Today's Post » Study hints that alpha may be finite (at least in the short term):

"As the hedge fund industry smashed through the one trillion dollar level a few years ago, it became vogue to ponder whether the new assets would dilute existing alpha opportunities. Was alpha a finite resource that needed to be shared among an ever growing number of industry players? And if so, was the hedge fund industry destined to become a victim of its own success...?

Research seemed to indicate that average alpha was indeed on the decline as the industry grew. But many also argued that the industry was being diluted by “unskilled” new entrants.

But if the new entrants were really “unskilled”, their effect on the returns of the incumbents should be minimal. If a group of 200 “skilled” managers were joined by 5,000 dart-throwing monkeys, then the original 200 should arguably be able to maintain their aggregate alpha. The simian stock-picking efforts of the monkeys should cancel themselves out...."

The finding? Sure enough the collective alpha of the industry fell thus supporting the long held view that competition will drive down abnormal returns.


BTW the finding that new entrants outperform (on average) existing participants really should not be surprising given that the new funds were presumably created to take advantage of an existing pocket of inefficiency and for at least a short period of time, would be more liekly to outperform.

The article is based off of this Weidenmueller and Verbeek paper.

Good stuff.

What is a hedge fund and how is it different from a mutual fund?

Had a student ask this question this semester so I am sure he was not the only person who does not know:

From Examiner.com What is a hedge fund and how is it different from a mutual fund?:

"Hedgefunds, unlike mutual funds, employ a wider array of ivesting techniques, which are considered more aggressive. For example, hedge funds often use leverage to amplify their returns (or losses if things go wrong).

The other key difference between hedge funds and mutual funds is the amount of regulation involved. Hedge funds are relatively unregulated because investors in hedge funds are assumed to be more sophisticated investors, who can both afford and understand the potential losses. In fact, U.S. laws require that the majority of investors in the fund are accredited."

Yes, Your Favorite Hedge Fund Manager Is Probably Just Lucky

ClusterStocks' Henry Blodget pointed this out yesterday: The actual link is from Ken French, so you know it is good!

Yes, Your Favorite Hedge Fund Manager Is Probably Just Lucky: "Your favorite hedge fund manager has walloped the market by 5% per year for the past 10 years, so he's obviously a genius, right?

Actually, no. He had a one-in-five chance of doing that just by throwing darts."

From the April 29th Q&A with Ken French:

"If we pretend his returns are normally distributed, the probability that his average abnormal return exceeds 5% per year for a ten year period is more than 20%. In other words, in a group of hedge fund managers with standard deviations of 20%, we expect one in five to have a ten-year average annual abnormal return of at least 5%—even if none actually have any skill. We expect one in twenty of the unskilled managers to produce a ten-year average annual abnormal return of at least 10%."

When you consider large number of funds and that many underperforming funds "drop out" of samples (sure not for academic papers anymore, but in reports and marketing it is still a major issue), it is easy to see why many believe they (or their fund managers) have the ability to outperform.

Hedge Fund Manager Strikes Back at Obama - DealBook Blog - NYTimes.com

Wow. Hard hitting letter by Clifford S. Asness of AQR Capital Management opposing Obama's comments attacking hedge funds in the wake of the Chrysler bankruptcy. Much good. My favorite part:

Hedge Fund Manager Strikes Back at Obama - DealBook Blog - NYTimes.com:

"...it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can. They are allowed to be charitable with their own money... but if they give away their clients’ money to share in the “sacrifice”, they are stealing....That’s how the system works"

First ETF To Mimic Hedge Funds Set To Launch - News In Focus

I am excited about this! If for no other reason it is good to talk about something other than gloomy regulations.

First ETF To Mimic Hedge Funds Set To Launch - News In Focus:

"The first exchange-traded fund designed to replicate hedge fund strategies is set to launch on Wednesday.

After receiving a final green light from the Securities and Exchange Commission at midday, the IQ Hedge Multi-Strategy Tracker ETF (NYSE: QAI) should start trading by day's end, according to IndexIQ Advisors LLC.

If it's able to truly mimic popular fund-of-hedge funds, the new ETF could provide the first real challenge to a fee structure critics characterize as highly exorbitant."

And note the last sentence. Gee, markets do work. If hedge fund fees are too high, competition comes into the arena.

Oh and how will it work?

"The benchmark for QAI resembles a fund-of-funds portfolio since it includes six different types of hedge fund strategies. The idea is to capture the entire hedging universe rather than singling out one or two strategies. The ETF includes hedging strategies covering long-short; global macro; market neutral; event driven; fixed-income arbitrage and emerging markets."

Half Of Hedge Funds Will Go Bust

From FT via Clusterstock.

Half Of Hedge Funds Will Go Bust:

"...poor investment performance for some, and asset value erosion for many more, have shrunk collections from management and incentive fees. It would come as no surprise if at least half of the entities in this space were to disappear in the next two years, either through mergers or failures.

Traditional investment managers are not immune to this rash of institutional shrinkage and consolidation. For some, the collapse in worldwide equity prices over the last 15 months has already shaved off about half of their operating revenues, rendering their current cost structure overwhelming and threatening the retention of talented staff."

Wow. That would be a large consolidation even with takeovers.

Strategies - The Index Funds Win Again - NYTimes.com

Strategies - The Index Funds Win Again - NYTimes.com:

"Kritzman... set up his study to accurately measure the long-term impact of all the expenses involved in investing in a mutual fund or hedge fund. Those include transaction costs, taxes and management and performance fees....Then he calculated the average return over a hypothetical 20-year period, net of all expenses, of three hypothetical investments: a stock index fund with an annualized return of 10 percent, an actively managed mutual fund with an annualized return of 13.5 percent and a hedge fund with an annualized return of 19 percent. The volatility of the three funds’ returns — along with their turnover rates, transaction fees and management and performance fees — was based on what he determined to be industry averages.

Mr. Kritzman found that, net of all expenses, including federal and state taxes for a New York State resident in the highest tax brackets, the winner was the index fund....Expenses were the culprit. For both the actively managed fund and the hedge fund, those expenses more than ate up the large amounts — 3.5 and 9 percentage points a year, respectively — by which they beat the index fund before expenses.."

History repeats itself

What a GREAT article. It is by Carole Loomis in Fortune, but comes to us via AllAboutAlpha.com

Featured Post Today's Post » Hedge fund industry enters time-warp in January 1970, pops out virtually unchanged in 2008:

A few look-ins:

"...the similarities between the hedge fund world of 1970 and that of 2008 and truly amazing - almost eerie in fact. Even the 39 year old Warren Buffett makes a cameo in this piece. As Motson pointed out to us, “…if you re-scale the numbers it could have been printed yesterday.”

and later:

"“…there is some disagreement these days as to the definition of a hedge fund…it would appear that they key feature of a hedge fund is neither the hedge nor the leverage, but instead the method by which the general partners are compensated.”

and still later:

"“Investing with the Stars”

Think Britney Spears and Sylvester Stallone were the first celebrities to invest in hedge funds? Think again. FORTUNE also reported that Jimmy Stewart, Rod Steiger, and Jack Palance were all co-investors in one California-based fund."

Great great piece. Very interesting and it reminds us the importance of history.

Hedge fund withdrawls, leverage, and future job prospects

Citadel Hit Hard as Hedge Fund Withdrawals Continue - Seeking Alpha:

"The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses.

Even if that prophecy only becomes partially true, that is a massive amount of deleveraging, unwinding, and liquidation. Forced selling is driving this market and will continue to do so"

More on the redemptions is available from Naked Capitalism which also correctly points out that the leverage that allowed more assets to be bought when money flowed into the funds, will result in more assets being sold when money flows out:

"Note that leverage figure is disputed....But even if that lower figure were true, redemptions of $150 billion would generate sales of $300 billion.

This semester my classes are exclusively upper level and grad classes, so regularly job prospects coming up in before and after class discussions. Over the past several years many of our graduates have one on to work at hedge funds so it is not surprising that some current students want to work in the field. Hence some coverage of jobs in the field is also warranted.

The Options Group estimates that 10,000 employees in the approximate 150,000 field will be laid off this year. From Bloomberg:

"Hedge funds may cut as many as 10,000 jobs this year as they struggle with their biggest losses in almost two decades, according to estimates by executive search firm Options Group.

The industry has already eliminated 3,000 to 5,000 jobs, out of an estimated 150,000 worldwide, Michael Karp, chief executive officer of the New York-based firm, said today in an interview. Layoffs may double by the end of 2008, he said.

``It's bad out there,'' said Karp, whose firm has tracked hedge-fund hiring since 1995. ``Generating returns is not easy at the moment and as funds look to cut costs, the best way is to let go of people.'"

A look at Bear and Goldman

Bloomberg.com: Worldwide:

"When Bear Stearns's two funds, High-Grade Structured Credit Strategies and High-Grade Structured Credit Strategies Enhanced Leverage, nosedived in June, the company tried to forestall a total collapse by halting withdrawals and unloading securities to meet lenders' demand for more collateral. That strategy failed, and Bear Stearns was forced to bail out one of the funds with a $1.6 billion loan. Investors in the other fund were wiped out. Goldman took a different course of action. When assets in the firm's Global Equity Opportunities hedge fund dropped by 28 percent this month, Goldman yesterday pumped in $2 billion of fresh capital and raised $1 billion more from investors"

Thanks to the NY Times' Dealbook for pointing out this article!

The Hedge-Fund 'Clones' - WSJ.com

Hedge fund clones are designed to mimic the return on hedge funds without quite so high of expenses or minimums.

The Hedge-Fund 'Clones' - WSJ.com:

"...the most common type of hedge-fund cloning, known as the factor model approach, works: Firms analyze a few years' worth of hedge-fund returns, often using data from hedge-fund indexes. The firms then essentially reverse-engineer those returns, using complex mathematical models to create a portfolio of easily traded investments that would have delivered the hedge funds' performance over that period.

That group of investments becomes the clone's portfolio for the next month. Then the process is repeated, typically each month, and the portfolio is revised."

Like the brownies on ATHF, it is doubtful that the clones will be able to match the real thing:

"Andrew Lo...whose research helped to spark clone products, says he has found that the clones will capture only about 40% of hedge-fund returns. One reason: Some hedge funds are especially hard to mimic, such as those that try to profit from events such as corporate bankruptcies, because they often hold hard-to-trade securities that are off-limits to clones."

Hedge funds and performance

Given all the attention hedge funds have been getting over the past few years, it is good to be reminded occasionally that when measured against a proper benchmark most hedge funds do NOT outperform. The following is from Ramit Sethi writing at Iwillteachyoutoberich.

I Will Teach You To Be Rich » Behind-the-scenes New Yorker article on hedge funds reveals they aren’t so sexy:

"...people with access to hedge funds — even they may be getting substandard returns in exchange for their participation in hedge funds. This is just another example of investor psychology and the importance of realizing that people are not always rational with their investments."

Sethi also cites Malkiel and Saha:

"After examining results of now defunct firms, Malkiel and Saha found that between 1996 and 2003 hedge funds made an average return of 9.32 per cent, significantly less than the 13.74-per-cent average return of funds included in the published databases."

Defnitely a good reminder and definitely not what you would expect if you just listened to popular press.

More on Bear, Regulation, and transparency

Mark Gilbert writing for Bloomberg has a well done piece on the implications of the hedge fund problems at Bear Stearns.

Bloomberg.com: Opinion:
Two lookins:

"The most stunning aspect of the demise of two hedge funds belonging to Bear Stearns Cos. is the almost total absence of transparency surrounding the bailout.

The debacle may finally provoke regulators, who have long suspected that buying derivatives is akin to running through a fireworks factory with a lighted blowtorch in each hand."

And later:

"The unraveling of the Bear Stearns hedge funds has pulled back one corner of the curtain shielding the activities of hedge funds and their investments in derivatives, giving a glimpse of who is on the hook if the bets sour.

It seems that the skin in the game isn't from other hedge funds, Asian central banks, or widows and orphans. Instead, step forward the usual Wall Street suspects: Merrill Lynch & Co., Lehman Brothers Holdings Inc., Bank of America Corp. and their investment-banking peers."

Definitely read the whole thing. It is good.

Bear Stearns taps managers to save hedge fund - Yahoo! News

Updates:

Bear Stearns taps managers to save hedge fund - Yahoo! News:

"Bear Stearns Cos. Inc. said on Tuesday it does not plan to bail out the High-Grade Structured Credit Strategies Enhanced Leverage Fund, the second of two struggling hedge funds.

Instead it will provide $1.6 billion of financing to save its High-Grade Structured Credit Strategies Fund. Days earlier the bank had said it would provide up to $3.2 billion in financing."

Also

" Bear Stearns Asset Management CEO Richard Marin is taking a stronger role in managing its two troubled hedge funds and tapped mortgage unit head Thomas Marano to save one of the funds"