Regular readers and those holding the CAIA designation know the name Alexander Ineichen. Ineichen has applied his unique brand of wit and irreverence to making sense of the financial crisis (see his 3-part short story The Ineichen Dialogues on AllAboutAlpha.com) and before that to his book Asymmetric Returns (see post) and other research papers (see posts here and here). If you have a CAIA charter hanging somewhere in your office, check out the signatures. Ineichen is a board member.
Last week the prolific commentator published an 80 page paper called “Absolute Returns Revisited.” Clearly, he felt that recent tectonic shifts, including the pronounced lack of “absolute returns” in 2008, required him to revisit the basic premise of hedge funds and alternative investments (and, it turns out, to propose an “alternative Richter Scale for measuring them.)
Fellow CAIA board member Peter Douglas told us on the weekend that the paper was so funny in parts that he would be sending Ineichen a cleaning bill for his office. Said Douglas “It was so funny, I nearly lost my lunch laughing.” He’s likely talking about the following observation, among others:
“It (managing a pension fund over the past decade) is like jumping from the 81st floor: The “false belief “held during the first 80 floors is that one is flying.”
Ineichen is a disciple of George Bernard Shaw, who once said “My way of joking is to tell the truth. It’s the funniest joke in the world.”
Anyway, the paper covers many topics of interest to AllAboutAlpha.com readers.
On the term “absolute returns”…
“…if a long-only fund is re-branded to include the “absolute returns” moniker, it does not mean that it is indeed an absolute returns vehicle…Buyers beware. A lot of mischief has been done with this term…We do understand that the absolute return moniker lends itself well to ridicule after 2008.”
On the recent under-performance of funds of funds…
“In the most recent past FoHFs seemed correlated with the equity markets on the way down but decoupled on the way up. Through much of FoHFs history it was the other way around; equity like returns on the upside and bond like returns on the downside. There is some limited solace in the fact that FoHFs still look good relative to equities which is of course not what investors had signed up for. The FoHFs investor’s drawdown is less severe than that of a comparable long-only strategy in equities. This is a weak argument in the fund of funds’ defence; but it’s an argument nevertheless.”
On Warren Buffett…
“We have reverse engineered his investment record within Berkshire Hathaway: 12.0% per year…This is pretty good, but does it qualify him for the reputation he has as the “world’s greatest investor”? Had the same investors liquidated their holdings in Berkshire Hathaway and had Buffett the asset manager manage the proceeds in the Buffett Partnership, the $70 million would have grown to $4.4 billion in 40 years. This is a far cry from the $153 billion of market cap that BRK/A enjoys today…
“Stated another way, if Buffett had been run over by a truck 40 years ago but Berkshire had done all of the same things that it did in the meantime, except that it invested in the S&P 500, Berkshire would still be worth $26 billion (versus $2.2 billion in the S&P or $4.4 billion with a manager who could consistently generate returns of 12%)…
“…had Berkshire invested in the S&P 500 and been in Bermuda, it would have been worth $323 billion or twice what it is today (the most valuable company in the world – without Buffett).”
(Related post: Buffett’s Horse Race)
On UCITS and NewCITS…
“Investor demand is arguably strong, fuelled by concerns about transparency, risk management and liquidity. It is undeniable that this market is growing rapidly in terms of number of funds and in terms of assets under management. Institutional investors have been the early adopters of the concept but it is the private banks, which are likely to bring this to the next level. Funds of hedge funds are also entering in this space with more than 25 multimanager UCITS launched to date (March 2010).”
(Related post: UCITS and NEWCITS: A better mousetrap?)
On Managed Accounts…
“…the renewed interest in managed accounts is mainly a consequence of recent negative liquidity experiences such as gates and side pockets, as well as the impact of some high profile fraud cases.”
On the hype around the need for clarity around the term “alpha”…
“At one level the “alpha talk” became a language that especially FoHFs could speak and institutional investors understood. At the beginning of the institutionalisation the mindset as well as the industry-specific language was materially different between the traditional industry and the hedge funds industry. This gap started to close rapidly when institutional investors started to look into hedge funds more seriously. It wasn’t lost on the hedge fund industry that the term “alpha” also works in marketing; with some market participants continuously pointing out, that it is marketing where hedge funds really excel. (Neither was it lost on the traditional fund industry that the term “absolute returns” has some marketing magic associated to it.)”
(Related website: AllAboutAlpha.com)
Overall, Ineichen’s subtext is that financial markets don’t seem to learn from their past failures. As he writes:
“Sometimes we feel like Bill Murray in Groundhog Day where the main character, TV meteorologist Phil Connors, wakes up every morning to live through the same day over and over again and being the only one aware of the repetition. It’s the same in finance during a crisis while many stakeholders behave as if the same repetitions hadn’t already happen before.”
Those of you with a soft-spot for out-there thinking might be thinking the same thing we are: Is this apparent foible a result of ignorance alone or is it a self-repeating first principle of human nature – a fractal if you will. If fractals are as ubiquitous as they say (Ineichen quotes Nassim Taleb, a disciple of Benoit Mandlebrot, the father of fractal mathematics), then why can’t they explain human behavior? Humans might ignore previous financial cycles, previous investments or previous trades. It’s all the same – a Groundhog Day containing a Groundhog hour containing a Groundhog minute.
In any event, this article is definitely worth a read over lunch sometime (just make sure you finish chewing it first).