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Hedge Fund Replication Strategies |
HenryTo
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 Posted: Wed Aug 01, 2007 10:11 am Post subject: Hedge Fund Replication Strategies |
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Not sure if any of you have read this but would be interested to know what you think of these strategies. The links to the various papers quoted in the article are located at the bottom of the page:
http://www.economist.com/finance/displaystory.cfm?story_id=8086854
| Quote: | | Replication is possible because hedge-fund managers are not as distinctive as they claim. They say their returns are based on skill, or “alpha”, but in fact their performance is largely derived from market movements. A recent paper* by two academics at the Massachusetts Institute of Technology breaks down the returns of 1,610 funds from 1986 to 2005. It finds that six common factors, such as the change in the S&P 500 index and the return on corporate bonds, explained a significant part of hedge-fund returns. |
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Hedge Fund Replication Strategies Replies |
rffrydr
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rffrydr
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| Posted: Sat Feb 06, 2010 8:06 am Post subject: |
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The Madman makes a good point: hedge fund, esp. of the recently reminted variety, cannot afford two down months at the start of the year. Selling is self-preservation.
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rffrydr
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| Posted: Sat Nov 21, 2009 7:44 am Post subject: |
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Thanks for that, Bill. I think we see the rationalization for all the black-box trading this last few years. And the marked change in market character. That alpha dive to zero was probably enough for most institutional money; and the (not) surprising ascendancy of the "convertible bond" model to explain most hedge-fund returns is symptomatic of this last bull cycle driven by fear of the very markets themselves. 2000 will haunt for a long long time. Indeed indexing and even the "hedge-fund" itself is symptomatic of this era. See "Greed born of Fear" below.
| Quote: | The very goal would
be to separate systematic risk exposure accurately from
true manager alpha. The former constitutes what an index
is all about, while the latter by definition should not be
part of an index/benchmark. |
As if one didn't beget the other. How much "alpha" is achieved by just by embracing systematic risk at just the right time? And conversely.
It'll be interesting how this scaredicat policy adjusts to the risk embracing strategies of the emerging economies. By their calculus markets are the least to be feared and offer a true egalitarianism their political economies have long denied--and "returns" never even on offer. These forces are daily intermingling and bumping up against one another. But if we follow the old adage, "follow the money" I wonder how long before we start modeling communist investment in african ore indices and the black boxes turn red!?
Go Managed Futures, go!
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nodoodahs
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nodoodahs
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| Posted: Sun Nov 15, 2009 7:23 am Post subject: |
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Even the replication proponents in academe admit that there are idiosyncratic aspects of HF returns that they can't duplicate. Some even suggest going long several FOF and shorting a replication product as a "portable alpha" strategy.
Even so, as practiced by the players, it's about matching either the FOF index (or a strategy index) and not about matching any particular HF.
Read some more and found there are about 3 players out of more than a dozen that are actually shooting for some absolute return products at low-vol rather than mimicking the FOF indices. It looks like they are setting those targets to please institutional asset allocators and not shooting for the max possible risk-adjusted return, but at least a few are setting out in the direction I would take the technology.
Agreed there's lots of non-ETF-able ops for differentiation in today's market (and some in every market).
Edit to add: comment also in this thread http://www.marketthoughts.com/forum/viewtopic,p,35641.html#35641
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rffrydr
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| Posted: Sat Nov 14, 2009 9:59 pm Post subject: |
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Einhorn did alright buying under(un)priced mortgage CDS. Nothing Buffett about that.
There are so many assets facing a binary outcomes it would seem there's never been a better opportunity for differentiation here. In fact that will be a condition to a any new bull market. And who's gonna ETF Steele Partners foray into japan this last five years?
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Last edited by rffrydr on Sat Nov 21, 2009 7:48 am; edited 1 time in total |
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nodoodahs
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| Posted: Sat Nov 14, 2009 10:51 am Post subject: |
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| HenryTo wrote: | More hedge fund replication strategies coming.
...
IndexIQ Advisors, a start-up firm that seeks to replicate hedge fund performance, on Tuesday launched the index-based IQ Hedge Macro Strategy Tracker ETF (MCRO.P), about 75 percent focused on emerging markets and 25 percent on global trends. The offering joins the IQ Hedge Multi-Strategy Tracker ETF (QAI.P), which began trading in March and is up 17 percent.
Both ETFs charge a fee of 0.75 percent and invest in a range of ETFs, with the exact mix determined by computers looking to mimic hedge fund returns.
... |
Been researching their methodology, and here's my major issue with it [which I've written about before, just maybe not here]:
These synthethic strategies are underutilizing their time trying to replicate the return distribution of a hedge fund index or hedge fund strategy.
I know that they're trying to market their product as a replacement for the "alternative investment" asset class allocation used by institutional investors, and thus, making it behave like something they've seen already (the existing HF indices), but why?
The exact same methodology could be used to find the combination and weighting of so-called "beta assets" to maximize the risk-adjusted return stream, rather than match some target return stream. The return stream produced could then be the primary asset marketed to HNW individuals. Over time, it could prove itself to be relatively uncorrelated to traditional asset allocations and THEN work its way into the institutional investor class as a superior product to, rather than as a cheaper replacement for, traditional hedge funds.
There's one guy in the replication space who's off in left field, marketing a custom product that can develop a return stream with different statistical measures (kurtosis, standard deviation, correlation) to complement the investor's existing other allocations. While he's (somewhat) on the right track with ignoring the HF return distributions, the problem with what he's doing is that he's not focusing on the average (median/modal/compounded whatever) return of the stream! Really, the average return is very important when talking about blending two or more streams, because adding a return stream with negative detrended correlation to your existing streams might LOWER your total risk-adjusted return, if the added stream doesn't have a high enough average return.
So yeah, I think the products have potential, but would like to see them used more originally.
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HenryTo
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| Posted: Sun Jun 14, 2009 3:14 am Post subject: |
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More hedge fund replication strategies coming. As mentioned in the previous posts on this thread, the vast majority of HFs don't add any alpha on a market/risk-adjusted basis, particularly after accounting for fees. The best HFs (including Buffett's best trades) involve either being a market maker or providing liquidity to the financial markets (such as Buffett's rescue of GEICO in 1976) - and most HFs are in no position to engage in this kind of transactions:
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Flood of ETFs promising hedge fund-style returns
Tue Jun 9, 2009 4:27pm EDT
By Joseph A. Giannone
NEW YORK, June 9 (Reuters) - Money managers are flooding the market with exchange-traded funds (ETF) and mutual funds designed to give even the smallest of investors access to hedge fund returns without all the usual restrictions or hefty fees.
IndexIQ Advisors, a start-up firm that seeks to replicate hedge fund performance, on Tuesday launched the index-based IQ Hedge Macro Strategy Tracker ETF (MCRO.P), about 75 percent focused on emerging markets and 25 percent on global trends. The offering joins the IQ Hedge Multi-Strategy Tracker ETF (QAI.P), which began trading in March and is up 17 percent.
Both ETFs charge a fee of 0.75 percent and invest in a range of ETFs, with the exact mix determined by computers looking to mimic hedge fund returns.
And there's a lot more to come. IndexIQ in April told the Securities and Exchange Commission that it plans to launch as many as 15 exchange-traded funds emphasizing different hedge fund strategies. The next offerings to come include a natural resources ETF, which will invest in stocks, and an inflation- hedged product buying a mix of commodity and equity ETFs.
"We intend to own the alternative investments space," said Tony Davidow, head of distribution at IndexIQ and former leader of Morgan Stanley's institutional consulting services. "We'd like to be the Vanguard of the hedge fund business."
The tiny firm, managing $100 million across a mutual fund, separate accounts and now two ETFs, is a long way away from catching up with the pioneer of the index mutual fund movement and its $1 trillion of assets.
And there is a growing number of competitors in this corner of the market.
Davidow says index funds offering hedge fund strategies can be beneficial to all investors, muting ups and downs and generating returns not tied to the overall market.
Since its launch nearly one year ago, the IQ Alpha Hedge Strategy IQHIX.O mutual fund has been flat, which is good compared with a 22 percent decline in comparable hedge funds and a 25 percent fall in the broader U.S. equity markets.
Disappointing hedge fund performance last year and redemption blocks have angered big investors and created a rare opening for new offerings. Firms such as IndexIQ, WisdomTree Investments and Grail Advisors intend to take advantage of the popularity of ETFs while offering strategies that used to be exclusive to the super rich.
San Francisco-based Grail Advisors LLC on Tuesday said it plans to launch four actively managed exchange-traded funds. RiverPark Advisors LLC will serve as lead sub-adviser for the RP Growth, RP Focused Large Cap Growth, RP Technology and RP Financial funds. Trading of these ETFs is expected to begin Sept. 1.
WisdomTree Investments, a money manager that has launched dozens of fundamental-weighted index ETFs, on Monday filed papers for three actively managed hedge fund-style ETFs: WisdomTree Real Return Fund, WisdomTree Managed Futures Fund and WisdomTree Long-Short Fund.
The lines dividing hedge funds and mutual funds have been fading over the past year.
AQR Capital Management LLC, a hedge fund firm with $20 billion under management, in January expanded into the mutual-fund business with the AQR Diversified Arbitrage Fund ADAIX.O. That was followed by its AQR Global Equity Fund AQGNX.O in February.
Highbridge Capital Management LLC, a unit of JPMorgan Chase & Co (JPM.N), has managed the JPMorgan Highbridge Statistical HSKAX.O Market Neutral mutual fund since 2005. |
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HenryTo
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| Posted: Thu Aug 02, 2007 12:00 am Post subject: |
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More quotes from the New Yorker article:
| Quote: | Veryan Allen, an investment adviser and former hedge-fund executive who writes a blog about hedge funds (hedgefund.blogspot.com), said in a post last December, “If Goldman Sachs, Dow Jones, Merrill Lynch, Andrew Lo, or Harry Kat think they can do it, great . . . but I suspect investors will end up disappointed if they think the returns from hedge-fund clones will be anywhere near the performance of the best hedge funds.” Allen went on, “No matter what occurs in the markets, well-managed ‘expensive’ hedge funds operating proprietary strategies with skilled traders, robust risk management, and technology will perform, even under pessimistic economic scenarios. . . . That is why it is worth paying the two and twenty. . . . Average or generic hedge funds can certainly be replicated, but not the best hedge funds.”
When I asked Kat about the hedge-fund industry’s reaction to FundCreator, he said, “People say, ‘Look, you don’t generate any alpha.’ After fees, I generate a lot of alpha. I just generate it differently. Instead of trying to beat the market, I get the fees down.” He conceded that there will always be hedge funds whose returns FundCreator can’t hope to match, but he argued that even some of the most prestigious funds owe much of their success to luck. “You can be fortunate,” he said. “You can live off market trends for quite a while. As in credit spreads”—the difference in yields between different types of bonds. “Credit spreads start to come down, and you make lots of money in credit. A couple of guys from an investment bank’s credit desk jump out and start a fund. If they are lucky, the trend continues for another couple of years, and they will look like masters of the universe. But when the trend reverses, or when there is no trend left, they are in trouble. If a guy has done well for two years, what does that mean? He could be really smart, or he could be really lucky. If I had bought stocks at the end of 1997 and you had looked at me at the end of 1999, I would have looked brilliant.”
It is notoriously difficult to distinguish between genuine investment skill and random variation. But firms like Renaissance Technologies, Citadel Investment Group, and D. E. Shaw appear to generate consistently high returns and low volatility. Shaw’s main equity fund has posted average annual returns, after fees, of twenty-one per cent since 1989; Renaissance has reportedly produced even higher returns. (Most of the top-performing hedge funds are closed to new investors.) Kat questioned whether such firms, which trade in huge volumes on a daily basis, ought to be categorized as hedge funds at all. “Basically, they are the largest market-making firms in the world, but they call themselves hedge funds because it sells better,” Kat said. “The average horizon on a trade for these guys is something like five seconds. They earn the spread. It’s very smart, but their skill is in technology. It’s in sucking up tick-by-tick data, processing all those data, and converting them into second-by-second positions in thousands of spreads worldwide. It’s just algorithmic market-making.”
Almost by definition, there can be only a handful of genius investors, Kat continued. “And even if they are there, the chances that you will find them and that they will let you in are very, very slim,” he said. “That’s what I tell people. If you are really convinced that you can find those super managers, then don’t waste your time with our stuff. Go look for them. But if you are a bit more realistic, if you know that eighty per cent of hedge-fund managers aren’t worth the fees they charge, then the rational thing to do is to give up trying to find a super manager, and just go for a good, efficient diversifier instead.”
Not so long ago, Kat recalled, one hedge-fund manager, a “global macro” investor who specializes in betting on currencies and stock markets around the world, approached him with an offer. “He said, ‘Harry, I want to buy your thing so I can replicate myself. Then I’ll be able to enjoy life a bit more and keep sending my clients bills for two plus twenty. It’ll take them years to figure it out, if they ever do.’ |
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HenryTo
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| Posted: Wed Aug 01, 2007 11:46 pm Post subject: |
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New Yorker article on hedge fund replication:
http://www.newyorker.com/reporting/2007/07/02/070702fa_fact_cassidy?printable=true
| Quote: | Truly outstanding investors, such as Warren Buffett, somehow generate consistently high returns at low risk. Kat decided to determine whether hedge funds met this standard; only if they did could they genuinely be said to have created alpha. In a study published in the June, 2003, issue of the Journal of Financial and Quantitative Analysis, he and a co-author, Gaurav Amin, an analyst at Schroder Investment Management, a British financial firm, compared the fee-adjusted returns of seventy-seven hedge funds between 1990 and 2000 with the returns generated by a market benchmark that had a similar risk profile. Seventy-two of the funds—more than ninety per cent—failed to outperform their benchmarks.
With the help of a graduate student, Helder Palaro, Kat also undertook a larger study, in which he examined more than nineteen hundred funds. The results, which Kat and Palaro posted online as a working paper last year, showed that only eighteen per cent of the funds outperformed their benchmarks, and returns even at the most successful funds tended to decline over time. “Our research has shown that in at least eighty per cent of cases the after-fee alpha for hedge funds is negative,” Kat told me. “They are charging more than they are adding. I’m not saying they don’t have skill; I’m just saying they don’t have enough skill to make up for two and twenty.”
Stephen Brown, William Goetzmann, and Bing Liang, researchers at New York University, Yale, and the University of Massachusetts at Amherst, respectively, have published data suggesting that the fees paid by investors in many funds of funds negate most or all of what is generated in extra returns. And several groups of researchers—including William Fung, of the London Business School, and David Hsieh, of Duke; and Jasmina Hasanhodzic and Andrew Lo, of M.I.T.—have shown that broad market movements in the prices of stocks, bonds, and other common securities account for a good deal of the variation in hedge-fund returns. These findings suggest that stock picking, trading smarts, and computer algorithms are less important than many scholars had thought. “Our idea was to see how much of the variation in hedge-fund returns you could explain using very simple, passive investment strategies,” Lo said. “Given all the hype and mystique surrounding hedge funds, we expected the answer to be ‘very little.’ We were quite surprised to find that it was about forty per cent.”
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HenryTo
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| Posted: Wed Aug 01, 2007 11:42 pm Post subject: |
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Conquest Capital on hedge fund replication:
http://www.eurekahedge.com/news/07_july_Conquest_Hedge_Fund_Replication.pdf
I have not read the above paper and haven't studied hedge fund replication in great detail. But I have read (mostly from Andrew Lo of MIT) that most hedge fund strategies can be replicated, with the exception of "Event Driven" strategies, such as buying distressed debt. |
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nodoodahs
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| Posted: Wed Aug 01, 2007 11:46 am Post subject: |
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The main trouble with strategy is deciding what you want. After that, it's just a question of time and data.
I've not found anything impressive about any of the complicated hedge fund strategies I've studied, and nothing that can't be implemented by anyone, subject to capital constraints - some strategies take minimum levels of capital to enact.
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