If you can’t find alpha in the hedge fund forest, does it exist?

Existential, philosophical questions have long been our focus AllAboutAlpha.com, particularly when it comes to hedge funds, alpha and the debate over whether the two go hand in hand.

Much to our dismay, however, has been recent discussion about whether alpha even actually exists, and if it does, whether it is “safely” attainable – i.e. in a cost-effective, transparent and liquid kind of way.

A recent survey of institutional investors by Create-Research suggests they certainly think it is. The report, entitled Exploiting Uncertainty in Investment Markets (click here and proceed to the link – a brief and free registration is required to download), finds that not only do institutional allocators expect to be able to find alpha over the next few years, they believe that hedge funds will remain a main source of it.

The survey, which included responses from 237 asset managers and pension plans in 29 countries with a combined AUM of $29 trillion, focuses on asset allocation, multi-boutiques as winning operational models, charges and fees, and fiduciary overlay.

Of specific interest to us was that a full third of survey respondents believe hedge funds will be one of the main sources of alpha over the next three years, as investors continue to seek high performance and new sources of non-correlated returns.

About 45% said active management would become more popular and 41% said alternative investments would become popular again, according to the report, which was produced in conjunction with Principal Global Investors and Citi.

Despite the demand – and belief – in pursuing alpha, the outlook for hedge funds still isn’t entirely rosy. The report’s authors noted that while the worst of the credit crisis appears to be over, “the days of halcyon asset growth are over for the foreseeable future.”

So what will drive the growth? “Organic” factors, according to the survey, including global economic prospects (cited by 52%); rising prosperity in the emerging markets (41%); recovery in equity markets (50%); and growth in private pensions in Asia, Europe and Latin America (36%) (see chart below). The key beneficiaries will be the US managers with global reach.

The report notes that investors are increasingly looking for managers who put clients first. Half of the respondents said they were planning to implement performance fees that only kicked in once a high watermark had been reached and 43% said they expected to adopt low management fees coupled with a performance fee.

“The old risk-return trade-off was nullified by two show-stoppers: volatility and liquidity,” notes the report. “Now, intelligent asset allocation and risk aversion top the client agenda.”

And where will the alpha-seeking money be put to work? According to the survey, assets will be increasingly segmented into different buckets to match anticipated liability profiles. Along those lines, clients’ faith in diversification — rudely shattered by cheap money — is staging a revival in three different ways.

First, the mix of asset classes is being made under different macro economic scenarios so as to pre-test it in the most extreme situations imaginable. Second, a distinction is being made between buy-and-hold investing, for long-term opportunities; alpha strategies, for excess returns net of fees; and tactical opportunism, for mispriced assets like distressed debt. Third, there is mounting interest in ETF-based exotic beta in pursuit of cheap exposures to different markets, sectors and geographies.

In short, if investors believe they can and will find alpha in the coming years, then by extension it is fair to say that alpha certainly exists. For obvious reasons, we’re glad to hear that – whether we’re in the thick of the forest or not.

Be Sociable, Share!

Leave A Reply

← Morningstar Operational Risk Flags: Due Diligence Goes Online White paper calculates the value of liquidity from a fund manager's perspective →