Economist article’s “catchy” title may overstate complexity a little
May 26th, 2008 | Filed under: Hedge Fund Industry Trends
This week’s Buttonwood column in The Economist says there is a paradox (a “catch two-and-twenty”) at work in the alternative investment industry. But when you think about it, the reasons for recent muted returns may be a lot simpler than appear.
“Catch” #1: If everyone invested in hedge funds, the average hedge fund would not beat the index.
“…suppose that every institution handed its portfolio to hedge-fund managers. The average fund manager cannot earn more than the market. After costs, he must earn less…”
Put forth as a sort of “victim of its own success” argument, this is a restatement of William Sharpe’s oft-cited 1991 article in the Financial Analysts Journal. In a way, everyone is already “investing in hedge funds” since every investor who is not a passive investor necessarily owns a small piece of (pure) active management embedded in their portfolios. So this argument, while entirely valid, isn’t specific to alternative investments. It’s also a “Catch 2%” for mutual funds or a “Catch 50 bps” for active long-only institutional investors.
“Catch” #2: Endowments and pensions pride themselves on their ability to earn an illiquidity premium, yet they strive for diversification.
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