By: Alpha Male 

When I came across syndicated columnist David Ignatius’ June 21 piece in the Washington Post on hedge funds a few weeks ago (“When Hedging Doesn’t Pay Off“) I passed it off as yet another populist attack on the hedge fund industry.  But I noticed that the original column was reprinted by various news organizations under vastly different and colourful titles ranging from “Good and Bad News in Global Interdependence” (Lebanon Daily Star), to “Learn from Financial Mistakes” (Denver Post) culminating in “Fall of the Portable Alpha” (Cincinatti Post).  I propose the title, “Journalist Misses Point of Hedge Funds Again”.

Ignatius cites a common argument against the ”non-correlation” of hedge funds:

“The investments that had proved most profitable — in emerging markets, commodities and other alternatives to large-cap stocks — all took nose dives. Investment strategies that supposedly were well hedged, so that losses in one sector would be offset by gains in another, turned out to be “correlated,” so that they all went down together.”

Many academics have illustrated that in times of distress, uncorrelated hedge funds tend to correlate temporarily.  But Ignatius uses a very blunt example.  Of course commodity funds, emerging market funds have gone down at the same time.  They also went up at the same time – primarily because they are not (uncorrelated) “hedge” funds.  No one ever said that “emerging market funds” were “well hedged” to begin with.  Transient correlation in (truly hedged) hedge funds is the result of hidden factors that act deep within the genetic make-up of many portfolios, not macro-factors that often appear in the funds’ very names. 

“…the chief economist of the International Monetary Fund cautioned June 8 that hedge fund managers were all chasing the same investment magic they describe as “alpha.” This was driving them like a herd into riskier assets and making them all vulnerable to the same potential reversals.”

Alpha is, ostensibly, the reason that the financial markets exist.  If alpha was not the goal of all professional investors from hedge fund managers to mutual fund managers, to private equity, real estate and commodity managers, then the markets would simply be a mechanism to allocated capital according to market cap.  Everyone would just buy a ETF.  Alpha is not new and its not magic.  Alpha is part of virtually every mutual fund. Hedge fund managers did not invent alpha (!)

“Portable alpha” is the term investment managers have given to the notion that by moving out of the S&P 500 universe, they can match the performance of George Soros.”

Please!  Trying telling that to the conservative pension funds that have indexed most of their return to the S&P500, then purchased a 5% exposure to the skills of an EAFE manager.

Clamoring for evidence to support his argument, Ignatius continues:

“Since May 10 emerging markets have fallen by about 25 percent, for example. Hedge funds have taken a smaller but real hit. In May the Credit Suisse/Tremont Hedge Fund Index was down 1.3 percent, the first time since October it has posted a negative monthly return.”

Emerging markets down 25%, hedge funds down 1.3%…The CSFB Hedge Fund Index sounds pretty well-hedged to me.  How did the “emerging markets” or EAFE sector do over this period?  And why isn’t Igantius writing about them?  The answer probably lies in the real reason the media uses hedge funds to sell papers:

“One factor pushing the market is the wildly outsize reward for alpha performance. For the top 26 hedge fund managers, the average pay last year was a jaw-dropping $363 million, according to a survey by Alpha magazine.” 

- Alpha Male