Walking the (Beta) Line

4 December 2007

In August 1956, Johnny Cash released a song that later became the title to a movie about the troubadour called Walk the Line.  In the song I Walk the Line, Cash promises his wife, Vivian, that he will remain faithful to her even with the temptations that come with touring.

In an October 2007 publication by Northern Trust, the firm says that hedge fund managers “walk the beta line”.  In other words, they walk a fine line between making sweet alpha and have a one-night stand with an exotic beta.

Says the article:

“Scores of hedge funds have lived up to perceptions in recent years, outperforming stocks in bull markets and reaping profits for investors even when equities are being hit hard. Still, not all hedge funds are meeting bold expectations. As a result, suspicion has grown that a large number of funds — even those insulating investors from market direction and keeping pace with the applicable strategy index — do not perform in a way that can be explained by the alpha-beta divide.”

But rather than joining the pile-on on hedge funds, Northern Trust - which is very active in funds of funds - argues that funds of funds still add a lot of value over and above a passive hedge fund (factor) replication offering.

• Driving by looking out a rear-view mirror: Says NT’s Anthony Zanolla “You don’t know how the composition of the index has changed. Managers may have gone out of business or changed strategies — you are looking in the rear-view mirror.” 
• Funds of funds perform better: “…the fund-of-funds index showed much less volatility than…and on a risk-adjusted basis performed much better than they did.”
• Funds of funds are dynamic: ”…a fund-of-funds team actively seeks out managers who can find profits in changing market conditions. Such a mandate often points to managers in emerging strategies, as opposed to categories where the potential for profit has dried up or become stagnant.”  

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