Flying Dutchman Portends Doom for Hedge Fund Industry
| Feb 13th, 2007 | Filed under: Alternative Beta & Hedge Fund Replication | By: Alpha Male |
|
The Flying Dutchman is a legendary ghost ship that is believed to be a sign of imminent doom for mariners. This fact is surely not lost on Dutchman Harry Kat, who today flew into London’s Landmark Hotel and launched a blistering attack on hedge funds at major hedge fund conference - questioning the industry’s very existence. Kat claims synthetic hedge funds solve several problems with the hedge fund industry including, in his words, annoying managers. So like the ship, is Professor Kat a harbinger of doom for the hedge fund industry? Or, is he yet another false prophet – one of many littering the hedge fund annals?
As regular readers will recall, Kat aims to replicate hedge funds - not by matching their returns, but buy matching only the distribution of their returns (conveniently, it turns out the actual returns generated by these cloned distributions happen to be around the same as those of the hedge funds themselves).
Here’s a quick analogy we find useful: Flip a coin 100 times, and when you’re done, have a look at the distribution. Normal with a mean of 50, right? Now imagine flipping another coin at the same time. Both distributions should be roughly the same. Both will have a mean of around 50 and be normally distributed. So you’d be indifferent between the two coins. But the coins still won’t produce the same results in lock-step with each other. In fact, they will produce different results around half the time. That’s the thinking behind Harry Kat’s hedge fund replication methodology. He doesn’t aim to literally replicate the monthly returns (i.e. in their exact same order). Instead he aims to replicate the return characteristics of hedge funds (their means, standard deviations, skewedness, kurtosis and even their near-zero correlations to various securities).
To continue reading this article please login (at the right) or click here to learn more about accessing our archives.
Related Posts
- Some (not so) random thoughts on the future of the hedge fund industry
- Who Needs Hedge Funds? A Copula-Based Technique for Hedge Fund Replication
- Alpha dogs of the hedge fund industry found to have taste for beta
- Hedge Fund Cloning to “Turn Industry Upside Down”
- Hedge Fund Replication: Indexation & duplication? Estimation & approximation? Or a declaration of innovation?
The fact that Kat’s strategy does not replicate the short-term returns of hedge funds, just mimics the distribution of returns, means that it should likely exhibit low-correlation with most hedge fund strategies. That could make the case for Kat’s strategies as extra source of diversification but not necessarily a replacement of hedge funds. The second question is liquidity. What is the capacity of a fund implementing Kat’s algorithms? Since it uses futures it is likely to be large but nevertheless limited. I would be rather surprised it can cope with the USD 2 trillion currently chasing alpha in the hedge fund world.