Kat: Why Accurately Replicated Hedge Fund Indices Won’t Do You Much Good
|Mar 3rd, 2007 | Filed under: Alternative Beta & Hedge Fund Replication, Guest Posts | By: Alpha Male||
“Kat’s Meow” – An occasional guest column for AllAboutAlpha
By: Professor Harry Kat, Cass Business School, City University (London)
Judging by the number of investment banks and asset managers jumping on the bandwagon, the media attention and the number of forthcoming conferences on the subject, hedge fund replication has definitely arrived in 2007. However, since it is all a bit new and all a bit much so suddenly, many investors seem to be somewhat confused and unable to ask the right questions. This brief note is meant to provide some guidance in this area.
A little bit of history first. Initially, hedge funds were sold on the promise of superior performance - the story being that hedge fund managers’ long experience and proven investment skills were a virtual guarantee for superior returns. Especially high net worth investors were sensitive to these arguments and fuelled much of the early growth of the industry. Starting in the late 1990s, hedge fund performance took a turn for the worst, however, with every next year being worse than the year before. The story changed accordingly. No longer were hedge funds sold purely on the promise of superior performance, but more and more on the basis of a diversification argument, pointing at hedge funds’ relatively low correlation with stocks and bonds and the beneficial effects on risk and return from including hedge funds in the traditional investment portfolio. Especially institutional investors proved sensitive to these arguments and started to pour large amounts of money into the sector, in the process making up for the outflow of some of the early private investors. Nowadays, there aren’t many serious investors left who still expect hedge funds to provide them with superior returns. The hedge fund game these days is all about diversification.
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