Pendulum swinging back to investable hedge fund indices for passive HF exposure
| Mar 18th, 2009 | Filed under: Alternative Beta & Hedge Fund Replication, Today's Post | By: Alpha Male |
Passive investment in hedge funds has always been somewhat of an oxymoron. Hedge funds, after all, aim to deliver active management (alpha). And since alpha is a zero sum game, a passive investment in hedge funds should deliver a zero return. Nonetheless, this axiom has always been challenged by proponents of various products designed to deliver aggregate “hedge fund returns”.
First there was the passive fund of funds; then came the investable hedge fund index; and finally there was hedge fund replication. In essence, all of these products delivered similar value propositions: diversification, transparency, and liquidity. (Despite the tendency for these providers to compete on returns, out-performance was never officially the goal of these “passive” products).
Hedge fund replication seemed to be the story of the year in 2008. But in the post-Madoff environment, the pendulum may be swinging back in the other direction. The investable hedge fund index – derided by proponents of hedge fund replication as being expensive and opaque since it invests in hedge funds themselves - is making a comeback. More…
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The two graphs also show that DB ARB is more volatile than the ETF, which explains why it lost more. In fact, wasn’t that higher volatility the big con behind DB ARB? Remember their marketing slogan: “We replicate gross returns”. As if you can do that without taking more risk. After 14 months of crisis (great job Mr. Paulson!) it is quite amazing to find investors still interested in traditional hedge fund replication. Haven’t they figured out by now that hedge fund indices just aren’t worth replicating? And even if, you don’t need a complex algorithm for that. Put the bulk of your money in T-bills, aind invest the rest in the S&P and a little CDS and hoopla. Replicated. Complex? Not at all. Try building a space shuttle. Now that is complicated.
strictly speaking, a passive investment in hedge funds can deliver positive alpha. this just means that hedge funds as an asset class are delivering average positive alpha, and other active investors are delivering average negative alpha. alpha still sums to zero.