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130/30 Not yet shining in Land of the Rising Sun6 August 2008
With several mega-institutional investors and a $120b public pension fund that has recently upped its hedge fund allocation, you’d think the sun would shine on short-extension strategies. But this month, the magazine reports:
Asian Investor cites several reasons for the slow uptake. Firstly, it says that many Japanese institutional investors view 130/30 as a sort of proto-quant strategy. And like all quant strategies, it should be avoided. Second, investors can’t figure out if 130/30 funds are hedge funds or long-only funds. Third, Japanese investors are still trying to come to terms with risk control, and fourth, the fees are different than traditional long-only funds. I asked Ted Uemae, President of AIMA’s Japanese chapter what he thought of these developments (or lack thereof). He told me that the abysmal performance of the Nikkei last year was partly to blame. With a return of -11.1% in 2007, Tokyo was the worst performing major developed country market in the world last year. Says Uemae:
Unfortunately, he notes, 130/30 is likely seen by Japanese investors as an extension of traditional long-only active management - bringing with it Nikkei beta. So institutions may essentially be leapfrogging, in some cases, right to absolute return strategies to avoid market beta altogether. Compounding this, says Uemae, is the usual hurdle of needing experience with shorting.
Asian Investor concludes that 130/30 may actually rise in China before it does in Japan. But despite the expected theoretical benefits of applying a short-extension to Chinese long-only funds, this recent article says that certain challenges remain (very rough, but interesting English translation by Google here). Last year, I gave a presentation on 130/30 in China and found that 130/30 was not a huge priority at the time. But I felt that this was a result of local institutional investors being overwhelmed with opportunities and other priorities, not a detailed analysis of the pros and cons of 130/30. In other words, it was as if they simply hadn’t gotten to it yet. If 130/30 dawns on the multi-trillion dollar Chinese institutional investment industry, then the future for Asian suppliers will be so bright, they’ll have to wear sunglasses.
Comments »Hedge Fund “Forum Shopping”5 August 2008
If, as one writer recently stated “the phrase ‘regulation of hedge funds’ is a contradiction in terms”, then it follows that hedge fund managers should be searching the globe for the most flexible regulatory regime in which to operate a fund. This is often referred to in legal circles as “forum shopping”. This isn’t to suggest that hedge fund managers spend their days looking for some screwball jurisdiction that lets them open a fund with a note from their mother or anything. Naturally, a fund’s jurisdiction impacts the level of comfort investors will have with the fund. But to some, it makes intuitive sense that certain jurisdictions should attract funds with certain strategies. But this paper by Douglas Cumming of Canada’s York University and Sophia Johan of the Tilburg Law and Economic Centre in The Netherlands concludes that this isn’t true after all. Say the duo:
In fact, they find the opposite - that hedge funds (in the CISDM and HFN databases) actively seek out the jurisdictions that are in the best interests of their investors “in order to facilitate capital raising”.
The regulatory characteristics used in the study as a proxy for a country’s regulatory burden are: a) minimum capital requirement, b) restrictions on the location of key service providers, and c) the number of permitted marketing channels. Interestingly, the countries with the most number of permitted marketing channels are (in rank order):
The US ranks at the bottom of the list at #24 - making it the least marketing-friendly jurisdiction (take note Phil Goldstein!). But the US also ranks among the most flexible when it comes to minimum capital requirements with a total of $0 required to hang out a shingle. While the authors do add a few caveats to their results, we might also add one more: There is obviously a huge home country bias driving the decision to domicile a fund. What would be interesting to explore is the propensity to domicile a second (i.e. off-shore) fund, not just a manager’s original fund. I, for one, have been involved with the selection of a jurisdiction for one such fund and found that regulatory requirements did indeed factor into the decision (along with the availability of key suppliers, tax issues and a variety of other highly idiosyncratic factors). Oh, in case you’re wondering, Cayman is one of the most restrictive jurisdictions on the list of 24 countries…
Comments »“Return persistence” can now be viewed with the naked eye4 August 2008
One author of a recent study on return persistence, Daniel Capocci, found that previous returns showed modest predictive ability and wrote on these pages last March:
Now Markus Schmid and Samuel Manser of the Swiss Institute of Banking and Finance and Credit Suisse say they have identified what they say is a better way to measure persistence - by looking at only one strategy, long/short equity. Taking aim at Capocci and others, they argue that lopping hedge funds with different investment strategies into the same analysis is less robust. Analysing just one strategy, on the other hand, removes strategy-specific betas from the equation. Like Capocci, they divide hedge funds into 10 portfolios depending on their previous performance. Then they track the performance of those portfolios going forward. Here’s what they found:
As you can see from this chart, the best performing funds during the “initial” period actually have a slightly higher chance of being in that category during the subsequent period. The worst performing funds during the initial period had at least as high a chance of remaining the worst performing - and triple the chance of dropping out of the database altogether. Unfortunately, when you look closely at this chart you also see that the best funds in the initial period also have a relatively high change of totally bombing in the subsequent period (either ending up in the bottom decile or falling out of the database entirely). There’s also a solid chance that the real stinkers from an initial period can actually vault to the first decile in the subsequent period. But despite this, there does appear to be some very modest evidence of persistence across different deciles. The chances of a 9th decile fund having been in that same decile during the previous period are above average (or more accurately, above the median). Same for funds in the 2nd, 3rd, 4th and 7th deciles. Still, these relationships are weak, say the authors, and “forming portfolios based on lagged returns does not seem to be a useful way to detect alpha portfolios”. Plus, rapid changes in return ranking could simply be the result of being long- (or short-) bias during a big market swing. So instead, they conduct essentially the same analysis using alpha instead of raw returns. The results are more promising: Now we’re talking! You don’t need a microscope to see that relationship. The return persistence across the middle of this chart can easily be seen with the naked eye. Say the authors:
The authors conclude by echoing the caution that Capocci raised in his AAA guest posting: that return-chasing (or at least alpha-chasing) succumbs to the friction costs of lock-ups and trading costs. But apparently, that doesn’t negate the significant value that can be added by a bit of pre-investment alpha analysis.
Comments »Build-Buy-Lease: Three Approaches to Alpha Generation3 August 2008We are pleased to present another commentary from the man who first coined the term “alpha-centric”, Angelo Calvello. Today, Calvello uses examples such as Man Investments and BGI to argue that there is more than one way for asset managers to become truly alpha-centric.
Investors, faced with funding shortfalls and stricter accounting regulations, are demanding innovative ways of achieving absolute returns. In the process, they are challenging the asset management industry to break down artificial barriers and constraints and consider solutions to problems we did not know existed a year or two ago. In many cases, these investors are offering those of us who can provide demonstrable value the opportunity to transform ourselves from vendors into partners who share their vision. The common denominator is the concerted focus on finding and generating alpha. The defining challenge for the asset management industry is to create and adopt business models and mindsets that will allow us to succeed in this new alpha-centric world. Multiple Sources Institutional investors are already seeking investment solutions beyond narrow, single-source portable alpha strategies. They are exploring and implementing multi-alpha solutions that provide exposure to multiple asset classes at the portfolio level. Because alpha is scarce, transitory and capacity-constrained, these solutions need to be structured flexibly so that alpha sources can be changed as they reach capacity or lose their edge. These solutions must also be structured to provide not just the desired return and volatility targets, but consistent positive returns while avoiding large losses. We have already seen the effect renewed shareholder and regulatory focus on pension plan liabilities is having on institutional investors. The growing interest in liability-driven investing (LDI) is a direct result of dissatisfaction with current best practices. Institutional investors are increasingly recognizing that their liabilities do not match the asset-class benchmarks in their strategic policy allocation, no matter how those benchmarks might be concatenated. Over the next five years in the US, a custom liability benchmark will likely become the minimum risk or risk-neutral position –or in the language of portable alpha, the beta–for many institutional investors, supplanting the asset-class-driven policy benchmark. Are you ready? These changes should cause an asset management firm to pause and consider if it has the tools to succeed in this unfolding alpha-centric world (in which success is tied to their ability to consistently and continually create, generate and sell alpha.) In this unfolding alpha world, alpha will remain scarce, transitory, and capacity-constrained. To survive, investment managers will have to become alpha hunters, continually searching for alpha. (Even managers at capacity must act this way because their current alpha source will eventually dissipate and possibly force them out of business). Asset management firms will have three non-exclusive choices in this search for alpha. 1. Build One possibility is to try to build alpha internally. Asset managers would reward portfolio managers according to their alpha-generating capability. Vesting the ownership of the alpha sources with the asset management firm gives them control of the process and managers, as well as a full share of all fees. However, there are also significant disadvantages. First, given the transitory nature of alpha, the firm is not assured of success. Second, the firm must have a culture that promotes and rewards generating and selling alpha, and this is not an easy task. The firm’s ethos must be alpha-centric as well as its organizational and compensation structures. Not all firms can act in this way, are willing to make the capital commitment or take the business risk required to move to and succeed in an alpha-centric world. Moreover, it takes considerable time not only to create an alpha-centric organization but to find and generate the alpha, with a long lead time and continued effort to become an alpha-centric organization and to find and generate alpha, with a long lead time before the results can be measured. Additionally, choosing to build alphas also produces a certain concentration risk—the risk that a single firm can overcome great odds to create and innovate truly diverse sources of alpha. Because alpha is fundamentally the result of human activity and a manifestation of human skill, it is and will continue to be expensive to attract and retain qualified alpha-generators, on the portfolio management as well as the research and development side. The recruiting issue cannot be underestimated as more and more firms will be competing for the same talent pool. On the whole then, building alpha allows for ownership and control but it is uncertain, time-intensive, inflexible, costly, and difficult to implement. 2. Buy Another option is to buy alpha generators (e.g., individual portfolio managers, teams of investment professionals, existing hedge fund managers). This would allow an asset manager to bring alpha-based products to markets more quickly and to fill in existing gaps in a firm’s product line. However, this also has drawbacks. Acquiring any alpha source is difficult, expensive, and suboptimal, given that alpha is scarce, transitory and capacity-constrained. The obvious risk with buying alpha is, of course, that manager skill, the key intellectual property at stake in an acquisition transaction, is an intellectual resource as fleeting as the alpha it seeks to generate. Additionally, an asset management firm adopting this approach must have two specific skills. First, it must be able to identify appropriate managers with the skill to ensure a good fit with the acquiring firm. This is a distinct and value-added skill for which clients pay significant fees to funds of hedge funds. If an asset manager has this skill, it should set up and manage its own fund of hedge funds. Second, even if an asset manager can find such talent (either directly or with the help of an intermediary), it must be able to value the alpha and structure a deal to acquire the firm or employees. This is a specific skill not often found with many asset management firms. In a world where competition for highly skilled managers will continue to be high, the firm must be prepared to pay a premium for a transitory and capacity-constrained resource. (This premium could also include the cost of capital to be allocated to the new firm or employees.) Moreover, even if a firm can find and acquire good managers at an acceptable price, the acquiring firm will still need the appropriate culture and structure to support the integration and ongoing generation of alpha. It must also have a contingency plan to deal with the likelihood of poor performance, alpha erosion, capacity constraints, and manager-related issues. In sum, buying alpha sources is expensive, difficult to execute well, inflexible, and laden with business risk. It would allow a firm to create or improve its presence in alpha world, but it does not carry any assurance of sustained success. 3. Lease Finally, a firm could consider leasing alpha by partnering with external alpha sources. This has several immediate benefits. First, it can be done relatively quickly and comes with low start-up costs (when compared with buy or build choices). It also provides the firm with access to a steady supply of renewable alpha sources suited to its needs while avoiding the problems associated with full ownership. (For example, the firm could try before it buys.) This leasing model is similar to the sub-advisory model used by many firms in the traditional investment management world and what funds of hedge funds do to create their alpha streams. Of course, there are certain disadvantages to this approach as well. The asset management firm must still be able to find successful alpha generators and structure an agreement with an appropriate fee-sharing arrangements and capacity commitments in return for distribution concessions. Perhaps more importantly, the firm must be able to anticipate and forecast new types and source of alpha. Leasing also requires the corporate humility to acknowledge that the firm cannot provide comprehensive asset management services. However, traditional asset management firms with outstanding distribution capabilities might be surprised to find that even outstanding managers currently closed to new investments might be willing to partner for the right kinds of assets. In sum, leasing is flexible, sustainable, easy to implement, and cheaper than the alternatives. It removes many of the barriers presented by alpha’s scarce, transitory, and capacity-constrained nature. It does require strategic insights, fee sharing, and the willingness for both parties to admit that the mutual benefit gained outweighs any loss of autonomy. The risk with this approach is that the leasee might not be able to continuously find sufficient alpha sources or that clients go directly to the alpha sources. Observations These three options should not be seen as mutually exclusive. An asset manager could achieve continued success by combining the three approaches. Depending on a firm’s business objectives and culture, a firm might start by leasing the required alpha while providing employees with the necessary tools and incentives to create proprietary sources of alpha. Over time, its direct experience with the leased alpha providers would allow it to determine whether it wants to acquire an ownership stake in these firms. (This lease-with-the-option-to-buy approach might be more expensive, but it allows the manager to overcome several of the barriers mentioned above: identifying and acquiring successful alpha sources that fit into the culture.) Conclusion The process of deciding whether to build, buy, or lease alpha will shed light on a firm’s strengths and shortcomings. Trying to do everything in-house seems a sure recipe for disaster, given the complicated and transitory nature of alpha generation. Instead, those firms that can establish partnerships seem more likely to have success. To succeed, firms could consider specifying its alpha needs in terms of amount, stability, beta exposure, correlation, capacity, fees, transparency, reporting, and liquidity, and, perhaps in the short term, contract with a firm that is skilled at identifying and accessing good and available managers. (If done properly, the use of such a procurement agent would be an interim solution. In fact, firms should structure the relationship with the agent so to enlist their help in building the internal skills necessary to perform their duties.) The acquiring firm might then hire an investment bank skilled in such alpha-related deals to help it negotiate a global agreement with these alpha sources to ensure fair pricing. Partnering could also help a firm augment its capabilities in other areas such as best-of-class risk management, accounting, compliance, or regulatory services. It also could work for those asset managers seeking to use structured products but lack the necessary skills or balance sheet. Because asset managers will be pressed to develop all the internal skills to succeed in this space, partnering appears to be the most cost-efficient alternative. Several firms have successfully adopted all three options. Man Investments, for one, is an example of an asset management firm that builds, buys, and leases alpha. Their leasing operation is manifest in their two large fund of hedge funds group, Glenwood and RMF, as well as in Man Global Strategies. (I would argue that their management of these leased sources of alpha reflects additional alpha, which in Man’s case was acquired when it purchased Glenwood and RMF but built internally in the case of MGS.) Man’s recent 50% purchase of the credit multi-strategy hedge fund, Ore Hill, and their 25% purchase of Nephila Capital demonstrates their willingness to buy alpha sources. The most obvious (and successful) example of Man’s willingness to buy alpha is their early acquisition of AHL, the largest hedge fund in the world. However, this “bought” alpha was quickly and successfully transformed into a “built” alpha as AHL, with Man’s support, built new proprietary alpha sources and techniques for managing capacity. Barclays Global Advisors (BGI) also built its business upon proprietarily developed alpha but supplemented it with alpha acquired through strategic hires. Their recently launched fund of hedge funds business is a pure example of leasing alpha. The success of these firms could be attributed as much to their culture as their business models, investment acumen, and management skills. Whatever combination a firm decides to choose, it is imperative that it recognizes that business as usual is insufficient to compete in this new alpha-centric world. Far-reaching structural and philosophical changes are required by the firm as a whole in order to fully embrace the possibilities presented by this new focus on absolute returns. Anything less will fall short. Angelo A. Calvello, Ph. D.
Comments »What Hollywood can teach us about investing31 July 2008We’ve gone fishing today. But before we left, we got to thinking about how Hollywood has inspired us over the years. So we assembled a collection of graphics we’ve used to describe some facet of alpha-centric investing. Click on the images below to view the original posting. The first person to identify the complete list of movies gets a free subscription to AllAboutAlpha.com…
Next week: TV shows on AllAboutAlpha.com
Comments »New data on hedge fund launches may be worse (or better) than first meets the eye30 July 2008
But hold the phone. Expressed as a percentage of the overall hedge fund industry, the 2008 number has got to be way lower than the previous 2002 low, doesn’t it? After all, growth during the intervening years has dramatically increased the size of the industry. In December 2007, we told you about a report by the European Central Bank than included the chart at the right. As you can see, global hedge fund launches amounted to about 20% of the industry from 1998 to 2004. Then in 2005 things started to change (although some databases indicated that 2005 was also a strong year for new funds). Curiously, this drop in launches didn’t coincide with a “bear market”. While ‘05 was described by some as a “disappointing year” for hedge fund returns, the drop in growth rates was likely also a result of the maturation and sheer size of the industry by that point.
Comments »More on Freud and Finance29 July 2008
In this article, Investment News reports that “Wealth management, family office and other advisory firms increasingly are using psychology — and psychologists — to work both with wealthy clients and the advisers who serve them.” While the story covers a more practical instance of the emerging field of emotional finance, you can see that it shares the same common theme as Taffler’s work (and also Denise Shull’s recent guest posting on AllAboutAlpha.com). While Taffler and Shull both argue that emotion affects trading decisions, the Investment News piece shows that emotion (quite naturally) also affects the wealth management relationship. Ergo, by getting into the heads of their clients, wealth managers can better address the sub-optimal decisions they make. As one expert cited in the article suggested, within 10 years most financial management firms will offer psychological counselling. Note to laid-off Wall Street professionals: consider becoming a shrink.
Comments »A picture of the “betafication” of alpha29 July 2008The commoditization of alpha has been a recurring theme on these pages (see, for example, “Alpha - once beatified, now beta-fied“). We came across the graphic below in a recent presentation given by Andrew Lo to the Society for Financial Econometrics in June. The presentation was called “What will happen to the quants in August 2017?”. But this particular slide sums up the inextricable evolution from alpha to beta.
Comments »Can asset managers balance “innovation” and “simplicity”? A new report says they better hope so.28 July 2008
Well apparently, asset managers have been busy. Here we are nearly 12 months later and a new survey by the Economist Intelligence Unit and KPMG finds that “51% of mainstream fund managers run long-short funds of the 130-30 type“. The survey was conducted in March and April and released in this KPMG document earlier this month. But it’s hard to compare it to previous surveys of the 130/30 industry due to the rather conspicuous terms “mainstream” and “130-30 type”. According to KPMG report, “mainstream fund managers” refers to “a filtered sample of respondents that excludes either alternative investment funds (private equity and hedge funds) or fund managers’ key clients (institutional investors)”.
Comments »Institutions tell pollsters “more fees”, “more consultants” and “more funds of funds”27 July 2008When Man Investments recently wrote that “FoHF [Funds of hedge funds] have been and will continue to be an integral part of hedge fund investing” (see related posting), they weren’t kidding. A survey released by IPE and Invesco this week seems to indicate that funds of hedge funds now have a market penetration of 100% among European institutions. In other words, every survey respondent that invests in hedge funds uses funds of funds for at least part of their portfolio (see chart below from their report).
Not surprisingly, the survey finds that equity-based hedge fund strategies fell out of favour, big time, amongst the European institutions canvassed. But with many respondents using a mixture of funds of funds and single strategies, it’s difficult to determine if investors actually moved money from one to the others. Suffice to say, funds of funds may not be falling out of favour after all (as some have suggested - see related posting).
Comments »Newsreel: Freaky Friday (hedge fund edition), single retirees, and performance fees=performance freeze?24 July 2008
Like the movie Freaky Friday, hedge funds and banks have switched bodies. John Snow says Fannie Mae and Freddie Mac are really hedge funds (Bloomberg) and hedge funds are side-stepping tightwad banks and lending money to each other (Financial News). Stay tuned for more zany antics! Online dating sites aren’t helping the elderly hook-up in Austria. But that’s a good thing for pensions who are saving a bundle by not having to support a pensioner’s spouse (IPE) Despite often issuing enough information to satisfy a Ph.D. in statistics, hedge funds get failing grades from advisors. A new survey finds nearly 90% of advisors rate hedge fund sales efforts as “ineffective” according to Investment News. As a follow-up to our posting on the rising cost of stock borrowing, we note that the FT ran a couple of interesting pieces last week: Rising costs of shorting hampering funds and Shorting ‘makes billions’ for groups. Those poor hedge funds. Suffering at the hands of evil pension funds. New data from Hedge Fund Research finds first half allocations to hedge funds increased by about a quarter of what they added in the same period last year. While that sounds horrendous, it wasn’t as bad as 2003. No worries, though. P&I reports that “Institutions stick to hedge-fund guns“. Says the newspaper: “…institutional investors weren’t the culprits…Institutional hedge fund hiring and search activity was strongly positive, totaling $19 billion…” But wait! Financial News reports that Morningstar found net redemptions from hedge funds up to the end of May. Did things really turn around that much in June? Or could measuring the hedge fund industry be an inexact science? P&I reports that Moody’s gave a raging endorsement to LDI, saying: “We believe the positives and negatives will tend to offset one another over the long-term, making LDI neutral to mildly positive for most issuers, depending on their unique facts and circumstances.” Okay. Not really “raging”. Contrary to some earlier academic research, one accounting firm finds performance fees don’t lead to better performance after all.
Comments »Is “regulation of hedge funds” a contradiction in terms?23 July 2008
“Hedge Fund Self-Regulation in the US and UK“ by Harvard Law School student John Horsfield-Bradbury was the recent winner of the 2008 Victor Brudney Prize in Corporate Governance for “the best student paper on a topic related to corporate governance”. Horsfield-Bradbury questions the ability of the industry to police itself, arguing that “self-regulation will not necessarily result in any efficiency gains as government regulators will remain the ultimate drivers of any regulation.” Horsfield-Bradbury sees hedge funds as a regulatory, not an investment phenomenon…
Comments »Can US retail investors “fend for themselves”?22 July 2008
The first, which we discuss below, was written by Houman Shadab of George Mason University. Shadab’s article “Fending for themselves: Creating a U.S. hedge fund market for retail investors” was published in the Spring 2008 NYU Journal of Legislation and Public Policy and is available here. In it, he argues that “financially sophisticated” US retail investors are actually hurt by regulations preventing them from investing in hedge funds, not helped by them. The second paper, covered tomorrow, defends government regulation of hedge funds, stating that ”self-regulation will not necessarily result in any efficiency gains as government regulators will remain the ultimate drivers of any regulation.” Shadab’s paper starts by saying that the US actually has a relatively restrictive hedge fund regulation:
Comments »Hedge fund clones calling in reinforcements for “attack” on funds of funds21 July 2008
But now Man Investments has borrowed the term to describe not just alternative beta strategies, but also other emerging strategies such as 130/30, investible hedge fund indices and “permanent capital” (exchange-listed shares in hedge funds). What’s the common link? They amount to what Man calls “hedge fund alternatives” that address the barriers of “high fees and comparatively poor liquidity” that prevent many institutions from investing in hedge fund strategies. In a report issued this month called, “Attack of the ‘hedge fund’ clones: Investable indices, Alternative beta, 130/30, Permanent capital“, Man ties together these loosely related concepts into one framework that is similar in its intent to this 2007 article, but with a lot more detail. As a result, this white paper is a great overview of alpha-centric investing that is succinct and easy to read - especially if you like smiley face icons…
Comments »Watson Wyatt: Investment managers now dominate the “pension fund food chain”21 July 2008
According to the report (available here with free registration), respondents “expected the appetite for alpha to rise” and that “interest in extra-financial financial factors (such as sustainability)” were seen as increasing. We covered some of the other data in this AllAboutAlpha posting. This month, Watson Wyatt completed the full report promised in the summary data above. It can also be downloaded here with free registration. This more lengthy narrative covers a lot of good issues, but a couple of observations really popped out at us.
Comments »Short positions throwing a wrench in the works for traditional (long-only) institutional investors17 July 2008
We stumbled across this article by BNY Mellon’s fund administration arm that reveals some of this complexity. The paper argues in favour of a holistic approach to portfolio risk analytics - an approach not always followed by institutional investors according to the firm:
Comments »The Road Ahead for Hedge Funds: Pot holes or sink holes?16 July 2008
In fact, Morningstar’s own press release yesterday observed:
The Morningstar release goes on reveal that performance chasing is alive and well in Hedgistan. While we have reported extensively about the flow of assets from smaller hedge funds to larger hedge funds, Morningstar’s data shows that money is also flowing quickly from stinky funds to ones that have maintained their bouquet through the credit crunch:
Comments »As markets fall, stock lending keeps on truckin’15 July 2008
In general, stocks are lent out on an ad hoc basis, allowing the lender (or more accurately, the lender’s agent, the prime broker) to set the “borrow fee” in a relative vacuum rather than letting the market dictate it. The resulting borrow fee is still loosely based on the supply and demand for the borrow. So if everyone wants to short a stock, then the demand will increase and the fee will rise. The possibility of a looming “shortage of shorts” has been bouncing around for some (see, for example, our posting “A Shortage of Shorts?” from November 2007). You’d think that a demand-driven increase in borrow fee would be accompanied by a commensurate drop in the price of the stock itself. After all, if everyone hates the company all of sudden shouldn’t the price fall? And as the price falls, shouldn’t some of the froth come out of the borrow demand (as marginal investors sense they have missed their chance to board the train)?
Comments »Making a negative call? Meet the new boss - same as the old boss.15 July 2008Sure, naked shorting and starting false rumours are socially undesirable. But isn’t there something a little ironic in the SEC’s clamp-down on negative opinions? Even the youngest junior analysts can remember a day not too long ago when the scarcity of any negative ratings was considered proof that research was actually just a lap-dog of the sell-side. Back then, with only one or two percent of analyst recommendations of the negative variety, the SEC wanted to see more “sell!” and less “buy!”. After peaking in 2003, sell ratings are still relatively rare - but they may become even rarer if the SEC starts to investigate people who don’t happen to love a particular stock. As Thomson reported today:
In May 2002, the SEC issued new rules to remove what it felt was a muzzle on analysts’ negative views. In the press release announcing its new rules, the commission said its goal was:
Comments »New study says widely-used models “can be particularly misleading in performance evaluation”14 July 2008
But what if the underperformance of actively managed funds has been driven by their underlying strategy, not their stock-picking buffoonery? Beneath the complexity of their recent paper on benchmark indices, that’s the question posed by Martijn Cremers and Antti Petajisto of Yale and Eric Zitzewitz of Dartmouth. (You may recall the names Cremers and Petajisto from their paper on “active share” – a new metric to measure active management. See related posting.) The researchers found that academic models aimed at isolating manager skill by adding new variables to the CAPM (such as the Fama/French and Carhart models) are a “substantial weakness”. Instead, they propose using actual indices as variables in an equation to reveal manager skill.
Comments »Alternative investing to be taken off endangered species list13 July 2008
Much as an animal is removed from the endangered species list when its numbers multiply, the report concludes that alternative investments may soon out-grow that moniker. Says the summary:
Notably, this year’s survey included questions on portable alpha and 130/30 strategies (appropriately, we might add, discussed in the same breath).
Comments »Weekly Newsreel10 July 2008
Swedish funds hope rules to change soon: The Swedish public pension scheme lobbies its government to allow more access to alternative investments. As P&I observes, “Alternatives managers — particularly global players — should be in the best position to benefit from what consultants estimate will be billions of dollars up for grabs.” Don’t Pay Alpha Fees for Beta Performance: Advisor Perspectives gives us a sneak peak at a new article by previous AllAboutAlpha guest contributor Larry Siegel on various alpha-centric themes. This is a great discussion - particulary for financial advisors. Hedge funds hit troubled banks with a hiring binge: More on a topic in last week’s newsreel - the employee pillaging being conducted by hedge funds. Bigger may be better as smaller hedge funds give up: Says one industry player, “The costs of entry into the hedge fund industry have always been very low, but the costs of remaining in business are very high.” Fewer U.S. hedge fund starts so far this year: Reuters reports on Absolute Return magazine’s analysis of US hedge fund start-ups. UK asset management industry moves towards multi-boutique model: Gartmore isn’t the only asset manager wrapping itself in the “multi-boutique” flag. Aberdeen changes tack on hedge fund strategy: Another UK-based manager says “Hedge funds are going to be a long term game and not a short term win.” (ed: especially for Aberdeen, which is now a quarter-owned by hedge funds)
Comments »A Note on Hedge Fund Fees: the Best is Yet to Come9 July 2008Angelo Calvello has been around the alpha-centric investing world longer than almost anyone. In fact according to our research, he actually coined the term “alpha-centric” investing. In a guest posting today, he applies this thinking to hedge fund fees. And what he concludes will surely surprise many.
I recently attended a conference on 130/30 strategies. The discussion eventually and inevitably drifted to the well worn but poorly understood topic of hedge fund fees and more specifically the inevitable compression of those charges. It is a debate founded on the belief that hedge fund fees are simply too high, although it is not clear what yardstick is being used to support this conclusions. Hedge fund fees could be compared to those charged by traditional long-only managers, but this would assume that fees charged for ‘active’ long only management fairly represent the value added by these strategies. This, of course, is questionable.
Comments »Are hedge funds really “clinging to hope”?8 July 2008
Battered funds cling to hope of recovery (Financial News): “Hedge funds are struggling to shake off their worst quarter since records began…” Hedge fund investors want out sooner, not later (Reuters): “Worried about hedge funds’ low returns and high fees, more well-heeled investors are now talking about getting out of these loosely regulated portfolios than getting into them…” HNWIs cool on allocation to hedge funds (Hedge Funds Review): “Allocation to hedge funds from high net worth individuals (HNWIs) slipped to 9% in 2007 from 10% in 2006…” Tough Markets Alter HF Managers’ Practices (HedgeWorld): “Last year’s turbulent market environment prompted hedge fund managers around the world to lower leverage ratios and move a significant share of their assets into cash…”
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In 
Authorities in the Cayman Islands 
“Performance persistence” is never far from the minds of both hedge fund investors and researchers. Many studies have attempted to determine if good managers can actually remain good or if their performance is destined to “revert to the mean”. In general, they conclude that persistence does exist…bad managers remain bad. Unfortunately, the opposite is not generally believed to be very true. 
Special to AllAboutAlpha.com by: Angelo Calvello, Ph.D.
New data released this week shows that Europeans just aren’t launching hedge funds like they used to. 
In a follow-up to a presentation we told you about in early June by Professor Richard Taffler (see posting - “
Regular readers may remember 
Yesterday, we discussed a recent article by a legal scholar that argues in favour of allowing US retail investors to buy hedge funds. Less SEC oversight would likely shift more of the onus on the industry to police itself. The recent release of recommendations from the President’s Working Group on Financial Reform in the US (see 
With all the finger-pointing going on right now on Wall Street, the topic of hedge fund regulation is never far from the front pages. So today and tomorrow, we will review a couple of comprehensive, but very readable essays written not by financial academics or hedge fund managers, but by legal scholars. These papers paint a contrasting picture of the most appropriate regulatory framework for hedge funds. 
It used to be that the term “hedge fund clones” referred exclusively to so-called “hedge fund replication” (a.k.a. “alternative beta) strategies. We noted in 
Back in January, consultancy Watson Wyatt released the high-level results of a study it co-authored with The Financial Times called “2020 Vision: Research on the Future Pension Landscape”. The study queried nearly 500 institutional investors from Europe and Asia on various issues.
The addition of short positions to traditional long-only portfolios adds a whole new dimension of complexity and requisite analytics. This was true for mutual funds (see 
As Dow Jones 
They say that the market for borrowing stocks (to execute short sales) is one of the last great inefficient corners of the financial industry - where participants can simply back their trucks up to the loading dock and use a pitch fork to shovel the cash inside. 
It seems to have become a financial axiom that actively managed mutual funds fail to justify their fees. Ergo, index funds are often proposed as the best way to lose the least amount of money. 
Last week, while JP Morgan CEO Jamie Dimon was busy 
Special to AllAboutAlpha.com by: Angelo A. Calvello, Ph.D. 
The list of stories below was lifted from the most recent edition of our “