At a conference on “alternative beta and hedge fund replication” here in New York today, attendees debated questions such as: What is hedge fund beta? What do institutional investors want from hedge funds and has this changed? and Is 2& 20 at risk?

But the elephant in the room was the question of what will happen now that so many short positions – the bread and butter of the hedge fund community – are no longer executable in many parts of the world?  The ban on short-selling seems to be snowballing as various jurisdictions slam the door in an effort to avoid becoming the last place on earth to short financials.  (For a great run-down of the current situation in various countries, see this post at FT Alphaville).  As one attendee here told me today, “This could be spell the end for hedge funds – at least in the short term”.

Will these new constraints on short selling breathe life into the recently anemic “hedge fund replication” business?  If institutional investors begin to steer clear of hedge funds but still want to tap into their unique return distributions and lack of correlation to equities, then we may be on the verge of a renaissance for these funds.

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Thomas Schneeweis

Michael and Cheryl Philipp Professor of Finance, Isenberg School of Management, University of Massachusetts (Amherst). 

Homepage (UMass)
Contact Information (UMass)
Center for International Securities & Derivatives Markets
Relevant Postings (AllAboutAlpha.com)
 

Much of the focus of this website is institutional (pensions, endowments, portable alpha etc.).  But many readers are also financial advisors who realize that many of the ideas adopted by institutions eventually make their way to the world of retail investments.  If you are such advisor, there is one online publication to which you should really subscribe: Advisor Perspectives.  This weekly e-newsletter often contains some interesting commentary on active and passive management – the retail version of many of the alpha/beta concepts discussed here.  Best of all, it’s free.

This week, it contains an interesting piece by a fee-only portfolio manager that recounts the story of how the founders of Google educated their soon-to-be rich pre-IPO employees on how to stay rich post IPO.  But while the story is presented as an endorsement of efficient markets, it may actually raise as many questions as it answers about the battle between active and passive management.

Says the article:

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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.

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This is the first of our series of guest articles (”Alternative Viewpoints – powered by CAIA”) written by a member of the Chartered Alternative Investment Analyst Association (CAIA Association).

By: Ryan Teal, CAIA

I was watching TV the other day and an advertisement came on for the movie, The Assassination of Jesse James by the Coward Robert Ford”.  The Jesse James character muses to a young, infatuated Robert Ford, Do you want to be like me, or do you want to be me?

This is what hedge funds must feel like with hedge fund replication.  Until recently investors have been told that hedge fund returns are not properly replicable but what happens if we can not only properly replicate these returns but do so at a significantly lower cost?

Recently I was able to view slides from a Thomas Schneeweis presentation called New Product Development: Replication vs. Indexation, in which he addresses this concept by discussing new replication methods available (such as Factor-based and Security-based replication), the theoretical basis for each and results from their performance against hedge fund returns.

Schneeweis illustrates below that many investors are now finally challenging the notion that hedge funds are not a pure source of alpha but in fact consist of a significant beta, or alternative beta, component.

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Heard on the floor at Terrapinn’s “Hedge Fund Replication & Alternative Beta” conference in Geneva so far today…

“His trading process may be “naive”, but his fees sure aren’t!”

- Professor Harry Kat on the hedge fund replication strategy pursued by another well-known firm.

“The asset information submitted to any of the databases is absolutely useless.  How many of the biggest hedge funds in the world actually provide an information to any database?  BGI, one of the world’s largest hedge fund managers, does not submit its data to any of the hedge fund indexes.”

“Five years from now, all hedge fund replicators will be out of business.  We’ll all look back and think ‘what a silly idea that was’!”

- Stan Beckers, Head of Alpha Management, BGI on hedge fund databases and hedge fund cloning in general

“Tom Schneeweis and I published our own hedge fund replication results on our website 6 years ago.  But we only got 2 phone calls…No one cared…so eventually we stopped doing it.  Apparently we should have continued.”

- Hossein Kazemi, Center for International Securities and Derivatives Markets (CISDM), jokes about his sense of timing in front of an overflow conference audience

Click below for more quotes from the lakeside…

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Visitors to our Events Section may have noticed that many of the world’s leading conferences on portable alpha, 130/30 and hedge fund replication are organized by Terrapinn or one of its subsidiaries.  Terrapinn’s events in this area have featured industry leaders such as Harry Kat, Bill Fung, David Hsieh, Rob Arnott, Thomas Schneeweis, Nassim Taleb, Laurence Seigel, Paul Wilmott, Angelo Calvello and others.

So we recently jumped at the opportunity to become the “official blog partner” of Terrapinn’s line-up of alpha-centric events from Toronto to Tokyo and from Sydney to Santa Monica.

One of the first projects to be undertaken jointly by AllAboutAlpha.com and Terrapinn is a survey of attitudes toward 130/30 investing.  We encourage you to take this brief 5 minute survey before August 24th.  In exchange for your time, you can expect to receive the summary results along with a reduced fee for a number of Terrapinn’s North American events.

As this partnership takes shape, you can also expect to hear from members of Terrapinn’s excellent speaker line-ups here at AllAboutAlpha.com in the form of guest postings and special contributions.

We hope you will agree that this partnership represents the perfect marriage between a physical community (a conference) and a virtual community (a blog).

In March, we learned that a reliance on monthly data to assess hedge funds might be leading us astray.  Thomas Schneeweis, Editor of the Journal of Alternative Investments, argued that daily, or even weekly, data was far superior than monthly information.

While Schneeweis was referring to the relative advantages of managed accounts at the time, the same general theme has now made its way into the debate on hedge fund replication.  Alpha Male shared a cold one with one of the luminaries of hedge fund academia a couple of months ago (a Hall of Fame member) when said guru expressed concern over the so-called “distributional replication” approach to hedge fund cloning.  In his opinion, Kat’s reliance on monthly data to pump out daily trading instructions was a source of potentially considerable error.

Now another group of academics, backed by one of the world’s largest hedge fund investors, has attempted to address this concern.  Nicolas Papageorgiou, Bruno Remillard, and Alexandre Hocquard of Montreal’s HEC Business School have just released the first version of a paper that aims to improve on the Kat-Palaro method (available here at AllAboutAlpha.com).  Papageorgiou tells AllAboutAlpha.com that Canada’s Desjardins Global Asset Management has been quietly managing a “beta” fund since late 2006 and will be adopting this approach for an official launch in September.  So expect to see Desjardins and Papageorgiou on red carpets around the hedge fund conference circuit this Fall (including this one featuring a panel of both Papageorgiou and Kat for – with apologies to Seinfeld’s Mr. Peterman - ”a good old fashioned Kat fight“).

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In the first of several randomly played “get out of jail free cards” we plan to use this summer, there will be no posting today.  Happy Independence Day to Americans everywhere.  And happy “US-Markets-Are-Closed-So-Take-The-Day-Off” Day to everyone else.

It’s also our first birthday today at AllAboutAlpha.com.  Over the past year, we’ve written over 130,000 alpha-centric words.  So if you’re enjoying a lazy summer day at the beach (with your laptop), we’d suggest you check out some of the other parts of AllAboutAlpha.com that you may not have seen yet.  For example, check out the latest additions to the research dossiers:

• (New) Hedge Fund Replication: 20 papers from Fung, Hsieh, Lo, Jaeger, Kat, Amenc, Schneeweis etc.
• (New) Fees: Nearly a dozen papers ranging from “Measuring The True Cost of Active Management” to “Highwater Marks in Hedge Fund Contracts”
• (New) Analytics & Metrics: Our newest dossier containing seven papers we have reveiwed at one point or another – from Alpha to Omega (from Andrew Lo’s recent “Where to Alpha’s Come From?” to William Shadwick’s “A Universal Performance Measure – Omega” 
• 130/30: Position papers from all the major suppliers including: Man, Merrill, Citi, Goldman, & Morgan Stanley
• Liability-Driven Investing: Various articles and academic papers on this application of alpha-centric investing
• The Morgan Stanley Portable Alpha Dossier: A great introduction to portable alpha along with several documents not publicly available on the web.

Or check out our Hall of Fame inclduing a “Who’s Who” of alpha-centric investing.  This section contains information on over 30 notable personalities from the world of alpha-centric investing – divided into four categories: academic foundations, entrepreneurs, hedge fund researchers and practitioners.

Or if you’re really looking for a good time, try going to “Search by Topic” and wading through hundreds of postings from the past year divided into 16 categories.

Hope you find these areas both interesting and useful.  We certainly do.

Happy Alpha-Hunting.

- Alpha Male

Owing in part to its tremendously prolific promotional department, few in the hedge fund industry are unaware that EDHEC Risk and Asset Management Research Centre – an off-shoot of the renowned Edhec Business School in France – is releasing its latest research on hedge fund replication today (Thursday) at a seminar in London.  The paper’s title summarizes Edhec’s take on the state of the replication world today: “The Myths and Limits of Passive Hedge Fund Replication: An Attractive Concept…Still a Work in Progress”.

While the full paper isn’t yet available to the public, our friends at Edhec have provided AllAboutAlpha.com with an copy so we can give you some of the main points. 

Overall, we find it to be a very good survey of the state of the replication field.  In the words of the authors, Noel Amenc, Walter Gehin, Lionel Martellini (Hall of Fame, related posting), and Jean-Christophe Meyfredi:

“The purpose of this position paper is to provide an in-depth analysis of the subject, with an emphasis on the findings based on the last ten years of academic research on hedge fund performance analysis and replication, and a discussion of the implementation challenges related to a commercial offering based on these concepts.”

The paper reaches two broad conclusions:

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George Main is one such manager. Fiercely Canadian, he laments the fact that he has rarely made any allocations to Canadian hedge fund managers out of his nearly $2 billion fund of hedge funds at Diversified Global Asset Management (DGAM).

Some of you might recognize George’s name from his recent stint as one of the speakers at GAIM USA in Florida last winter. Main is due to keynote Friday’s “HFM Live Canada” agenda with an address on alternative beta.

His approach to investing is somewhat unique. Most hedge fund investors will begin with the decision to invest in a single manager or a fund of funds. Once this critical first step has been taken, the investor will usually select a suite of hedge fund strategies in which to invest. After this, they will seek out the best managers within each hedge fund strategy. When they have selected appropriate managers, they will typically inquire about their edge – the fundamental economic engine of their out performance.

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Professor Harry Kat of the Cass Business School at City University, London, has been a thorn in the side of the hedge fund industry for several years now.  And today (April 30), he released his latest attack on the sector, reserving his sharpest barbs for the hedge fund replicators themselves.  In fact, he concludes his analysis by replicating both Goldman Sach’s and Partners Groups own hedge fund replication offerings.

The latest paper is an extended version of Kat’s earlier work “Alternative Route to Hedge Fund Replication”.  He adds over 20 pages of succinct and pointed commentary on everything from the research of Andrew Lo, Thomas Schneeweis, Lars Jaeger, Bill Fung and David Hsieh to the hedge fund replication offerings of Merrill Lynch, Goldman Sachs, JP Morgan and Partners Group.  If you are new to the whole “hedge fund replication” shtick, this is a must-read.  And if you have been following this story for some time, you will find Kat’s viewpoint typically concise – even if you don’t agree with it.

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Location: New York
Dates: October 29-31, 2007
Organized by: Terrapinn

Hedge funds aren’t the only thing replicating these days. February’s wildly successful “Alternative Beta & Hedge Fund Replication” conference in London has replicated itself – spawning two additional events within the course of a year. Both carry the same title and bring this hot topic to the shores of the US and continental Europe.

New York’s version has secured replication rock-stars Harry Kat (related posting), Lars Jaeger (related posting), Tom Schneeweis (related postings) & David Hsieh (related postings). In addition, they add quant stalwart Cliff Asness to the mix (related posting). One of the things we love about the hedge fund industry is the candor, passion and willingness to debate that it participants display. So we think this event will be anything but boring. Let’s get ready to ruuuummmmble, as they say in Vegas.

Geneva is also hosting an “AB & HFR” event this fall. More to come on that one when the agenda is available.

View New York Programme

Much criticism has been leveled at the venerable CAPM. For example, Thomas Schneeweis, Editor of the Journal of Alternative Investments recently told AllAboutAlpha that:

“The CAPM was devised in 1964. But by the time I got my Ph.D. in the 1970s, we knew that model was not really measurable. It’s amazing how long it’s lived on.”

Behavioral economists have led the revolt against CAPM. Economist James Montier recently called CAPM “Completely Redundant Asset Pricing” or “C.R.A.P.” for short.

In its defense, chronicler of the history of modern finance, Peter Bernstein, calls CAPM-inventor William Sharpe “the most important single influence” in his landmark book Capital Ideas. In a recent interview, Bernstein acknowledges empirical shortcomings of CAPM, but points out its significance:

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