By: Andrew Saunders, CAIA (AllAboutAlpha.com Editorial Board)

The last 12 months have been, to put it mildly, “disruptive” for the hedge fund investor.  No more so than for endowments, foundations and pensions that may have only recently invested in alternative investments.  This month we direct our “seven questions” to someone at the mine face who advises and educates these investors on their alternative allocations.

Greg Dowling is Managing Principal and Director of Hedged Strategies at Fund Evaluation Group, a 70-person investment consulting firm serving institutions such as pensions and foundations.

Q1: Greg, what about the recent 12 months surprised you the most, and how has it changed the advice you have given your clients?

It would be hard to pinpoint just one surprise. The whole sequence of events that occurred post-Lehman was not only surprising, but also all together shocking.  For years, you would hear from analysts covering the financial sector who worried about the investment banks and large money center banks’ exposure to hedge funds. In the end, it was hedge fund’s exposure to the banks that almost brought them down. There is certainly some irony here. One of the most regulated industries, banking, nearly collapsed, yet those “evil” unregulated hedge funds held up fairly well in comparison.

What has changed?  Well, you simply cannot make recommendations solely on a pure investment risk/return basis anymore.  You now need to consider the health and liquidity of both the client and the manager.

Q2: What do you see as the areas requiring the most client education today?

More…

Today, we bring you the first in a series of exclusive interviews with key players in the world of alpha-centric investing.  Approximately once a month, we’ll pick someone from the pages of AllAboutAlpha.com or from the alternative investment industry in general and pose 7 topical and straightforward questions.

By Andrew Saunders, CAIA (AllAboutAlpha.com Editorial Board)

Roger Ibbotson, Ph.D., is the Chairman and Chief Investment Officer of Zebra Capital, a role he has held since the firm was founded in 2001.  However, many of you will know Roger as the founder and former Chairman of Ibbotson Associates, which he founded in 1977. (He sold his interest in Ibbotson Associates to Morningstar in 2006 and is no longer an executive with the company.)

Roger is also a professor in the Practice of Finance at the Yale School of Management.  His book with Rex A. Sinquefield, Stocks, Bonds, Bills and Inflation serves as the standard reference for information on investment market returns.  He also co-authored two books with Gary Brinson, Global Investing and Investment Markets, and in 2001 completed an investments textbook with Jack Clark Francis, Investments: A Global Approach.  Roger also recently published the Equity Risk Premium with William Goetzmann and Lifetime Financial Advice with Chen, Milevsky, and Zhu.

As regular readers are aware, Ibbotson conducts research on a broad range of financial topics, including investment returns, mutual funds, hedge funds, international markets, portfolio management and valuation. He is a regular contributor and editorial board member to various trade and academic journals and has received several awards, including the Review of Financial Studies Award (Best Paper in 1992) and the Graham and Dodd Scrolls (6 times).   His publications are regularly listed in the Top Ten Social Science Research Network Download lists.

He has also served as a consultant to many companies in the financial and investment industry and has managed bond portfolios, traded equity securities, and managed asset allocation accounts.

Q1: Roger, as we approach the second year anniversary of the great quant meltdown of August 2007, how would you characterize investor familiarity, knowledge of and openness to quant strategies?

During the summer of 2007 the risk (volatility) of hedge funds doubled.  It was also a time when many strategies were highly levered and underperforming.  Since most hedged funds targeted volatility, many had to unlever at the same time. Many of the quant funds had similar holdings, which caused the meltdown as they rushed to the same exits.  During the summer of 2008, something similar happened, but this time the cause was the short selling restrictions that the government implemented in an attempt to prop up the most vulnerable companies.  Once again the quant strategies suffered.

In both cases, the quant funds that were able to stick with their strategies were able to quickly recover.  But those who targeted volatility got whiplashed.  Those who kept their leverage intact did reasonably well.  Unfortunately, many investors lumped quant funds into one big category, and have become wary of the whole group.

Q2: Are there questions that investors should ask about quant strategies but do not?

More…

Much of this three-day “no media” conference in San Francisco focused on the “tectonic shifts” going on the global economy (Day 1, Day 2).  Unlike previous versions of this particular conference, this new left-coast edition featured several economists specializing in the global economy – particularly in Asian economies.  From Nobel Laureate Michael Spence (chairman of the Independent Commission on Growth and Development) to academic and author Richard Koo (author of a recent book on what the US can learn from Japan’s lost decade) to this morning’s opening speaker Stephen Krasner, former Director for Governance and Development at the National Security Council.

As much as these macro-economic issues seemed to engage the sensibilities of the hedge fund managers and institutional investors in the room, one question was never far from the surface: so what?  How would these “tectonic shifts” affect the investment portfolios of the foundations, endowments, pensions, insurance companies and hedge funds who make the pilgrimage to Boston and San Francisco every six months for this gathering?

One obvious answer is that these macroeconomic dislocations could lead to opportunities for global macro, currency and emerging markets hedge funds.  But a recent research note from Vanguard shows that emerging markets may still be all about beta, not all about alpha.

The category of “emerging markets hedge fund” has always seemed a little odd to us.  Obviously, this category has a serious long-bias.  Check out Vanguard’s chart below showing the correlation between “emerging market hedge funds” and the MSCI emerging market index:

More…

We have moved the cast and crew of AllAboutAlpha.com down the street today from the Metropolitan Club to cover the “Battle of the Quants III“, an increasingly popular event that attracts both financial rocket scientists and mere mortals like your humble scribe.

Ray Kurzweil is billed by Wikipedia as an “inventor and futurist”.  And they’re not making it up.  He invented one of the first music synthesizers, the first flat-bed scanners and the first speech recognition software and has been recognized by three US Presidents, has written 4 best selling books and has several honorary doctorates to his name.  He also runs what he calls “a high frequency quant fund”.  He addressed the crowd of 100 on the topic of “accelerating pace of change” and “21st Century Technology and financial markets”.

Kurzweil is also well known for his views on “technological singularity” – the increasing frequency of so-called “Paradigm Shifts” over the past billion years and the ensuing exponential growth of information technologies.

On technological advancement: “Health and medicine is now an information technology.  The Human Genome is the software.  Now health – like other information technology – will begin to advance exponentially.”

On faxing physical objects: “In the future everything will be an information technology.  Someday, we’ll

More…

Barton Waring

Managing director and head of the Client Advisory Group at Barclays Global Investors.  Previously, head of Ibbotson Associates.

Bio (Yale Alumni Association)
Research (SSRN)
Relevant Postings (AllAboutAlpha.com)

Roger Ibbotson

Professor in the Practice of Finance, Yale School of Management.  Chairman and CIO of Zebra Capital Management, LLC. Founder, Advisor and former Chairman of Ibbotson Associates, now a Morningstar Company. Has written numerous books and articles including Stocks Bonds Bills and Inflation.

Homepage (Yale)
Ibbotson Associates (now Morningstar)
Research (SSRN)
Relevant Postings (AllAboutAlpha.com)

State Street world’s largest again: According to Pensions & Investments, State Street Global Advisors is the world’s largest institutional manager for the 7th year in a row ($1.8 trillion AUM).

“Best Blogs”: Speaking of P&I, we think they are one of the best.  Coincidentally, that’s exactly what they said about us in their recent ranking of “best blogs” (where they ranked us #9).

Increased regs not in the cards for hedge funds: Morningstar says their database is “the closest hedge funds are going to come to oversight” in the near future.

Seed capital providers now vital for funds: The FT reports that as assets get harder to raise, some are saying “seeders” are just about the only way to go for hedge fund start-ups.

Value Partners Says Smaller Hedge Funds Face Takeover: …and if smaller funds don’t have access to a sugar-daddy ”seeder”, guess what…

Several 130/30 funds come to the market: Investment Week reports that Roger Ibbotson is about to launch a 130/30 fund.

The hedge fund industry is big. Make that really big. Or sorta big?: Reuters provides a great summary of the myriad of ways to determine the actual size of the hedge fund industry.

Goldman offers mutual fund based on hedge fund index: After launching its Absolute Return Tracker (ART) index last year, Goldman has now built one of its own funds around the “hedge fund replication” model.

The LDI analogy of pensions and airlines: One expert says that airlines and pensions face the same challenge – fluctuating liabilities.

Battered funds cling to hope of recovery: One noted manager hits the nail on the head with regard to hedge funds’ PR problem, saying they “have an image problem among some institutional investors…the perception that the sector is dominated by cowboy attitudes, high fees and unfavorable risk adjusted returns.”

The Lo Down: The Economist scrapes bottom of pun barrel to draw attention to Andrew Lo’s new book.

Study finds managers prefer lean teams: This is exactly why we’ll never see a lot of lay-offs in the hedge fund industry.  There’s no one to lay off.

Portfolio construction job one, study says: Cerulli report says that two-thirds of asset managers surveyed are planning to develop alternative investments or products that blend traditional and alternative strategies.

Performance fees. No other words in the hedge fund lexicon seem to generate so much passion among both managers and investors.  But while the concept seems simple enough, it actually has implications well beyond the size of the manager’s bonus.

For example, a performance fee reduces return volatility.  In an up-month, the fee reduces the size of the return that might otherwise have been realized.  But in a down-month, the unrealized performance fee is essentially paid back to the fund - as if a negative performance fee had been charged.  Of course, after the fee is paid out at the end of the year, its gone for good and the worst a manager can do is to earn no performance fee the next year (see related posting for more discussion on intra-year negative performance fees).

Accounting for a performance fee can be a difficult task when conducting a back-test of a new trading model since the accrued performance fee in, say, December, would more than likely have impacted the manager’s strategy at that point.  So applying the same trading rules across the board and ignoring downside risk for the manager is unrealistic.

More…

Well, maybe not retirement per se.  But Ibbotson (now under the Morningstar umbrella) recently convinced examiners at the US Patent Office that adjusting a retirement portfolio based on the amount of time until a worker retires was patent-worthy.  According to the US Patent Office website, the patent was awarded on May 8, 2007.  But it wasn’t until last Friday that the firm released a statement saying “Nyaaa, nyaaaa!  We gotta a patent!” (we paraphrase here).

This patent reminds us of Research Affiliates’ recent patent on fundamental indexation (see related posting, “The Patent King of Pasadena“).  Both make liberal use of the terms “machine-readable medium…” and “processor performs the steps…” to differentiate their “inventions” from generic and broadly-understood concepts.  Says Ibbotson’s statement:

More…

By: Diana Raluca Calin, Reading University
Published: April 2006

EurekaHedge highlights an interesting paper on alpha and beta in hedge funds.  Written by a Masters student at the ICMA Centre at Reading University, the paper (a Master’s thesis using the EurekaHedge database) contains some interesting findings about the amount of alpha in hedge funds.

The author conducts a factor-analysis on Asian long/short funds to identify whether they contain any of the “good stuff” (alpha).  Her conclusion: yes, there is alpha in Asian long/short funds.  A similar conclusion was reached in a recent study of a broader set of hedge funds by Roger Ibbotson at Yale (see posting).  So hedge fund managers can breathe a sigh of relief for now – although the paper is unable to quantify said alpha.

But it does make a passing comment that we at AllAboutAlpha find somewhat contradictory:

“This excess return could be a result of market inefficiencies rather than manager skill.”

More…

By: Roger Ibbotson, Yale School of Management & Peng Chen, Ibbotson Associates
Published: September 2006

Whew!  There is alpha in them there hedge funds.  Ibbotson and Chen discover that hedge fund fees absorb about half of it, but it seems to exist nonetheless.  

Using a database of hedge fund performance from 1995 to 2006, they adjust for commonly-cited problems such as back-fill bias (where a hedge fund manager only decides to report returns when they go public – invariably with their winning funds) and survivorship bias (where the data only includes funds that did well enough to survive).  Here’s what they found…

More…