AllAboutAlpha Special Guest Posting by Harry Kat
Jul 1st, 2007 | Filed under: Alternative Beta & Hedge Fund Replication, Guest Posts, Hedge Fund Industry TrendsToday, July 1st, is Canada’s national holiday. As a result, we watched fireworks and drank “Molson Canadian” with the rest of our countrymen today and avoided blogging. In Alpha Male’s place, we welcome a special guest poster today in the form of the always controvertial Professor Harry Kat. Hot on the heels of a recent feature article in the New Yorker, Professor Kat shares his take on a common argument made in favor of funds of hedge funds.
“Funds of Hedge Funds and the 2000-2003 Equity Bear Market”
Special to AllAboutAlpha.com by: Harry M. Kat
At conferences, I tend to make the point that highly diversified portfolios of hedge funds tend to be highly correlated with the stock market and therefore do not make good diversifiers. When doing so, fund of funds salesmen rush to the microphone to point out that funds of hedge funds did not go down during the 2000-2003 equity bear market and that such protection alone is worth paying ‘3+30′ for. For simplicity ignoring the rather alarming fact that it only takes 6 years of paying fund of funds fees to lose the equivalent of a 40% drop in the S&P 500, this indeed looks like a strong point in favour of funds of funds. However, upon further reflection, this is not necessarily the case. In this short note I will clarify this comment. I will concentrate on the HFRI Fund of Funds index. As shown elsewhere, the multi-strategy hedge fund replication products offered by Merrill Lynch, Goldman Sachs, Partners Group and others tend to track this index quite closely.
Figure 1: S&P 500 and HFRI Fund of Funds index, 1996 – 2007
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