“Beta blockers” aim to reduce the blood pressure of those facing hedge fund gates
Jun 7th, 2009 | Filed under: Portable Alpha & Alpha/Beta Separation, Today's Post
Linear regression models (a.k.a. factor models) have a number of emerging applications in the hedge fund industry. One of the most often-cited here and elsewhere is hedge fund replication (see related posts). But as we discovered recently, regression-based models can also be used to estimate the daily returns occurring between monthly hedge fund reporting cycles (see related post). In addition, MIT’s Andrew Lo has proposed several other applications of linear factors models to address situations such as transitioning between managers and portfolio rebalancing for risk management purposes (see related post).
Now Lo has teamed up with Alexander Healy of Alpha Simplex Group (the company with which Lo is closely affiliated) and proposed yet another application of this truly alpha-centric approach to portfolio management: dealing with redemption gates.
The two suggest that when hedge fund investors are confronted with redemption gates, they can essentially remove their economic exposure to many of the underlying hedge fund betas in much the same way an executive can monetize un-vested stock options. By basically shorting the basket of betas that make up the returns of lock-up hedge fund allocations, investors can reduce volatility dramatically and in some cases, even increase returns (i.e., if the alternative betas in question temporarily deliver negative risk premia).
Drawing on a knack for colourful metaphors, Lo says this is not unlike the strategy taken by the drugs often prescribed to those with high blood pressure: More…
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