Whither the Clones?
Sep 17th, 2008 | Filed under: Guest Posts, Today's PostIt’s been about two years since “hedge fund replication” hit the mainstream business press. Over that time, many products have been launched and there has been much navel-gazing about the future of the hedge fund industry. But today “real” hedge funds remain. With such an elegent value proposition, and a stellar academic pedigree, why have the hedge fund clones not yet taken over the world?
This is one of the questions being addressed at a Terrapinn conference next week in New York. To provide a bit of perspective on the challenges faced by hedge fund replication, we invite one of the speakers at that event, UK-based Nicola Ralston of Liability Solutions, to share her thoughts. Ralston is also a former Chair of the CFA Society of the UK and a Governor of the CFA Institute.
Special to AllAboutAlpha.com by: Nicola Ralston, PiRho Consulting
Asset owners are an understandably sceptical group of people. They often feel it’s a jungle out there; investment banks and asset managers seem to make a very good living at their expense, yet everyone knows that real skill is a scarce commodity. Where to turn? In the equity markets, passive investing cuts the cost of gaining exposure to markets. It reduces the risk of being fleeced by managers who are trying, but failing, to add value and taking a big fee along the way. Why should hedge funds be any different?
Working out what to replicate
The concept of hedge fund replication assumes that we have an understanding of what we seek to replicate. This may seem fairly straightforward – even basic – but there are serious issues to consider. Even indices that broadly measure the same thing can differ significantly.
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“In the seven months to July 2008, for example, performance on the replication products we monitor varied between -15.7% and +3.8%.”
That -15.7% number comes from a failed Deutsche Bank product. The other products are in a very tight cluster. These are the unvarnished facts: alternative beta products- net of fees- have proven themselves in the most difficult market environment in hedge fund history.
For example, the Stonebrook Alternative Beta Fund (net of fees) had cumulative returns of 1.03% from it’s inception in May, 2007 through August, 2008. The compares to 0.04% for the HFRIFWC and -1.45% for the HFRIFOF indices. Moreover, Stonebrook had a 0.84 correlation to the HFRIFWC and 0.75 to the HFRIFOF. These returns are not dissimilar from our peers.
If you are an investor, you should be ask what percentage of fund-of-fund returns can be attributed to alternative beta. It should be your benchmark. And you should combine alternative beta with high-alpha managers to maximize the performance of your hedge fund portfolio.