It was only a couple of years ago that David Hsieh made an off-the-cuff remark that many took as a questioning of the long-term viability of the hedge fund industry (see related posting). He estimated that around $30 billion of alpha was available to hedge fund managers. This immediately started a round of navel-gazing in the industry the led to a number of competing estimates of the total supply of alpha in the world (such as this one by Lars Jaeger). Was alpha going to run out? Would the party be over soon? Was there a “peak alpha” theory? These became the dominant questions of 2006.
Now it appears those concerns were so “last year“.
Both Hsieh and Jaeger were among a dozen experts to address a packed audience in New York today at the inaugural US edition of Terrapinn’s “Alternative Beta & Hedge Fund Replication” conference. This time aorund, Alpha Male took a turn at being master of ceremonies. (see related postings on sister events in London and Geneva earlier this year).
Instead of worrying about the finite size of the world’s alpha supply, Hsieh, Jaeger et al argued that hedge funds would likely survive on a diet of “alternative beta” even if their traditional food source (alpha-generating market inefficiencies) ran out.
Rather than predicting the imminent demise of hedge funds, most of the speakers here actually argued that hedge funds have now become a delivery mechanism for alternative betas (whither “alpha”?). Even the institutional investors who took the podium today accepted the notion that hedge funds can be justified even if much of their returns were “hard to find” betas.
In doing so, they essentially revisited the accusation often leveled against hedge funds that they simply “sell beta at alpha prices”. It seems that many now believe that hedge funds are right to charge alternative beta prices for alternative beta. In other words, the industry may have reached a rare consensus with investors that alpha may not be as mystical as initially billed – but that hedge fund returns still cannot be easily replicated by simply buying ETFs. One speaker even warned the audience “Don’t underestimate the value of alternative beta”.
It’s clear that institutional investors have set a high bar for hedge fund managers. In order to justify so-called “alpha-fees”, hedge funds now need to prove they are delivering returns that cannot be found in less exotic forms (e.g. Deutsche Bank’s currency or commodity trades, Fung & Hsieh’s straddles, Kat’s exotic options). But what’s less clear is whether institutions also plan to beat up long-only managers about whether their alpha is actually just alternative beta. Ironically, the alpha portion of long only returns receives significantly less due diligence and is significantly less transparent that a typical (institutional) hedge fund. How do we know this? Because if their strategies had to undergo the same cavity searches as hedge funds, then the study of “alternative beta” would already be well established.
Oliver Schupp from Credit Suisse Tremont suggested that indexation (2004’s burning issue) would soon give way to replication. Like hedge fund indexation, he argued, hedge fund replication provided similar benefits to those upon which so many investable hedge fund indexes were built.
Merrill’s Benjamin Bowler said that liquid hedge fund replication products had many uses: providing long and short hedge fund exposures (especially where institutional mandates don’t allow hedge fund investments), liquidity management, portable alpha, derivatives/capital preservation, and benchmarking.
In a panel discussion to end the day, Investcorp’s Chris Acito reminded the gathering that most alpha “eventually becomes beta”. But he also added that alpha can also just disappear as it is arbitraged into oblivion. Alpha, he said, will only become (lasting) beta if it delivers a fundamental risk premium. (The Ford Foundation’s Larry Siegel actually coined the term “beta-fied” at 4:30pm today).
In the end, it appears that if hedge funds ever run out of alpha, then will have a viable second career second career delivering alternative beta. And while driving an alternative beta delivery truck is a far cry from being beatified, it sounds like it would more than likely pay the bills.
(note: Our good friend Matthias Knab of Opalesque will take over MC duties tomorrow on a day that features Harry Kat, Tom Schneeweis, Cliff Asness and many other big names in this field.)