Merrill Lynch: “New Alternatives in Alternative Investing”
Oct 21st, 2006 | Filed under: Hedge Fund Industry Trends
By: Benjamin Bowler, Heiko Ebens, John Davi & Giovanni Amanti, Merrill Lynch
Published: October 18, 2006
The end is nigh! The end is nigh! A new report from Merrill Lynch suggests the hedge fund industry faces the dreaded “Y2011 Problem”.
They point out that the growth trajectory for the number of US mutual funds in the 1980’s and 90’s is a dead ringer for the growth trajectory for the number of hedge funds (globally) in the past 15 years. If this pattern continues, the number of hedge funds in the world will peak at around 8,000 or 9,000 in 2011 (see chart).
Passive Strategies to Inherit the Earth…
Okay, maybe not the whole Earth, but a serious chunk of it. Why? Because passive alternatives will begin to crowd out new entrants - just like they did in the mutual fund industry. Like the quants at Barclays, JP Morgan and SocGen, the authors of this report espouse a new form of quasi-active hedge fund than produces exotic beta at fees above pure passive management (e.g. an ETF) but below pure active (hedge) funds:
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[…] Firstly, as we have discussed on this blog, the industry became quite concentrated between 2000 and 2006 (as the mutual fund industry did years earlier). As several respected institutional investors have told us recently, there are really only about 700-1,000 funds that would make it onto an institution’s investment radar screen (not 9,000). And according to research by Alpha Magazine, large segments of the industry actually shrank between 2004 to 2005. […]
[…] Will hedge funds succumb to the same fate as large chunks of the mutual fund industry: commoditization through ETFs and index funds? Merrill Lynch seemed to think so last October. And now, so do academics William Fung and David Hsieh. This research paper provides a “tool kit” to identify alternative beta, distinguish it from its hard-to-copy cousin, alternative alpha, and replicate it using basic trading rules that the authors say “capture the essence of hedge fund strategies”. These trading rules explain what they call an “accidental alpha” produced by traditional (linear) factor regressions. […]
[…] Interestingly, Hookway says the drive toward managed account-enabled DIY funds of funds is gutting the “plain vanilla funds of funds†sector.  In order to survive, he says, these funds of funds are either a) becoming more specialized or b) becoming index providers (a development that is reminiscent of the mutual funds industry). […]