We are pleased to bring you a special guest posting today by one of the big names in institutional money management.  But unlike most big names, this one comes from the ranks of investors, not asset managers.  Laurence Siegel (see related posting) is the Director of Research at the Ford Foundation.  He was co-author of a hugely popular article in the spring 2006 edition of the Financial Analysts Journal called “The Myth of The Absolute Return Investor” that took issue with many of the popular assumptions about absolute return investing.  (Siegel’s co-author, BGI’s Barton Waring is featured in a summer 2006 webcast on the topic).  In addition, Siegel was also co-author of a great piece called “Five Myths About Fees“, which originally appeared in the Journal of Portfolio Management.

Siegel is speaking at a conference next week in New York on the topic of alternative beta and hedge fund replication.  In this AllAboutAlpha.com exclusive, he gives us an overview of his thoughts on “exotic beta”. 

Are Exotic Betas Worth Investing In? A Brief Note.

By Laurence Siegel, Special to AllAboutAlpha.com

What are exotic betas?  What are clone funds?  Has the sober science of money management been taken over by aliens from outer space?

No.  Let’s start with a brief (but not brief enough) history lesson.  Hedge funds evolved out of active management, the attempt to beat a benchmark using security holdings weights that differ from those in the benchmark.  Hedge funds differed from traditional actively managed funds in being able to sell short and use leverage; and, typically but not always, in having no fixed mandate (thus no fixed benchmark).  Nevertheless active management, including hedge fund management, is always about beating some sort of neutral or normal portfolio that you would hold in the absence of any views.  That neutral portfolio is the benchmark; if the fund is perfectly hedged to all systematic market factors, then there is still a benchmark, but it’s cash.

More…