Day three of this un-nameable hedge fund event provided a bit of pessimism for everyone.  NYU professor Ed Altman got things rolling with a grim assessment of the US economy and successive speakers after lunch - namely professors David Hsieh and Harry Kat - presented research which they said was evidence that most hedge funds still weren’t making the grade.

Altman: Enjoy the Olympics America, then get ready for economic mayhem

In the conference programme, Altman’s presentation title contained over 30 words.  But the straight-talking and entertaining academic said it could be summed up as simply, “A New Paradigm or a Giant Credit Bubble?”

From the sounds of it, he comes down solidly in the “credit bubble” camp.  As evidence, he pointed to the massive increase in global liquidity (from petro-dollars, a growing money supply and sovereign wealth funds), an explosion in hedge funds, private equity funds, easy credit and low spreads, and growth in the CDO market (now 2 to 3 times the size of the global equity derivative market he says).

These developments, argued Altman, would lead to huge opportunities in distressed debt investing in the coming years (he’s a huge fan of distressed debt - check this out).   After apologizing for being excited about what he predicts is a coming wave of corporate bankruptcies, he shared the following secret with the audience:

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After a couple of power bars and a shot of orange Gatorade, conference-goers wearily made their way back into the Boston-area plenary hall that yesterday was the scene of a grueling 10 hour hedge fund marathon.  On the agenda today: 130/30, risk, fund of hedge funds and commodities.

CAIA Association Executive Director Craig Asche fired the starter’s pistol at 7:32am by announcing the results from day one and introducing one of the titans of fixed income investing and 130/30 advocate, Morgan Stanley’s Marty Leibowitz.

One of league’s all-time leading point-getters

If Harry Markowitz is the Mick Jagger of finance, then Martin Leibowitz is the Wayne Gretzky - holder of many of hockey’s individual records.  Like Gretzky, Leibowitz is the holder of several league records including the most number of articles published in the Journal of Portfolio Management and the Financial Analysts Journal.  He has also won consecutive Graham & Dodd Awards for financial writing and was the first inductee into the Fixed Income Analysts’ Society Hall of Fame.  In his new book, “Capital Ideas Evolving”, Peter Bernstein dedicates an entire chapter to Leibowitz (see related posting) and Leibowitz, like Bernstein, has been the recipient of the CFA’s “Award for Professional Excellence”.

Leibowitz is the celebrated fixed income pioneer who spent the first 25 years of his career at Salomon Brothers, the next 10 years as the CIO of $300 billion pension giant TIAA-CREF and then joined Morgan Stanley in 2005.  Today, he delivered a flurry of complex charts and tables that have become the hallmark of his 40 year career.  But his message was clear: too much of the typical portfolio’s volatility comes from the market and not enough from manager skill (a.k.a. alpha, ”active risk”). (Amen)

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If the nutritional content of conference snacks says anything about the physical and mental demands of the event, then this one is going to be the Kailua-Kona Iron Man Triathlon.  Instead of serving only glorified Twinkies and hotel coffee, organizers here plied us full of Power Bars and tasty little treats called “Balanced Gold high protein bars.”

Sessions began today at 7:30am and by the 10:00am coffee break, the audience had heard from no less than 3 panels and 2 individual speakers.  And this is the first of three full days of lectures and panels by academics and other freakishly intelligent practitioners.

The “Factor” Factor

If there is a theme emerging already, it’s “alternative beta”.  Investors seem to be questioning whether they are paying for alpha and receiving some kind of beta while for their part, managers seem to be wondering if alpha is becoming harder to produce in the first place.

This fundamental question weaved its way in and out of different sessions taking on various forms.  For example, panelists in a session on strategic asset allocation debated which was more important when they allocated capital: “the strategy” or “the manager”.

An ensuing debate about whether hedge funds qualified as a true “asset class” pitted those who said that hedge funds were just an equity strategy against those who argued that the fundamental factors driving hedge funds returns qualified them as a distinct asset class.

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Alpha Male is in Boston this week at a hedge fund conference with a strict “no media” policy.  As a result, it’s an event so secret, I couldn’t possibly speak its name.  But I have been authorized to say this: it’s in Boston and speakers include Harry Markowitz, Myron Scholes (a good Canadian kid), Benoit Mandelbrot (inventor of fractal geometry and one of Eugene Fama’s former professors), Mark Anson (formerly a bigwig at CalPERS), hedge fund researcher David Hsieh, Professor Harry Kat, and Morgan Stanley’s Marty Leibowitz.  In need of a talking head whose intellect certainly won’t make anyone here feel inadequate, organizers have also asked Alpha Male to be master of ceremonies for a small portion of the event.

It’s a gathering of several hundred investment managers and major pension plans (known as “allocators” in the parlance of the industry).  So in order to encourage a frank and honest exchange, organizers have quite rightly put the kybosh on any “quotes from the floor” segments on AllAboutAlpha.com.  Still, we hope to provide a high-level sketch of the major themes being discussed here and I’m sure we’ll revisit some of them in the weeks to come.

This is our second year covering the event.  You may recall last year’s edition from these postings.

Switching focus now from Geneva to New York, Alpha Male reports today on Managed Accounts USA, an event bringing together hedge funds, investors and those who participate in the burgeoning business of providing “managed accounts platforms” that some say will give rise to an age of “do-it-yourself funds of hedge funds”.

Many of the barbs usually lobbed at hedge funds have more to do with operations and less to do with actual investment strategy. Hedge funds are small businesses they say. Most hedge fund ‘blow ups’ are the result of operational issues – not investment issues. Buyer beware!

But the diversification and low correlation available from alternative investments (hedge funds, real estate, private equity, commodities and even high-alpha-proportion long-only funds), remain highly desirable.  So what can be done?

Enter managed accounts.  According to the chairman of Managed Accounts USA (UMass prof and CAIA co-founder) Thomas Schneeweis, managed accounts address many of these common concerns while maintaining the investment characteristics so desirable in hedge funds. This is especially attractive to institutional investors.  And with institutions forecast to become the dominant investors in alternatives over the next 5 years, managed accounts aren’t going away any time soon.

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Thomas Schneeweis is an academic. So he views the primary benefits of managed accounts not as operational, but as analytical. He argues that daily and weekly return data (usually only available via a managed account) is superior to the more common monthly data used in the hedge fund industry. Schneeweis tells All About Alpha that monthly data hides all sorts of things from, for example, volatility during the last week of every month, to a high correlation to intra-month shocks.  (Ross Miller of SUNY Albany shows the power of daily data in his recent paper on Fidelity Magellan’s uncomfortably high market correlation.)

Since monthly data points are generally in short supply (most hedge funds have been around for less than 100 months), all available data points are usually used to calculate things like beta, volatility and, of course, alpha.  But as Schneeweis points out, the composition of the S&P 500 has changed over the past 5 years.  So why examine 5 years of hedge fund correlations?

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Heard on the Floor…

MSS’s Simon Hookway on Hedge Fund Clones: Clones are themselves single-manager hedge funds.  I look forward to following their progress. If they do well over the next three years, I’d definitely be interested in including them in my managed futures/CTA portfolio. (Ed: said with tongue only partly in cheek)

University of Toronto’s Felix Chee on efficient markets: Markets are efficient, just not effective.  Markets are virtually frictionless – that is, they price securities according to all available information very quickly.  But markets are not good at determining if this information is fact or fiction.” (Ed: This ineffectiveness is reminiscent of Bernstein’s macro-inefficiency argument).

CISDM’s Thomas Schneeweis on efficient markets: Academics don’t believe in purely efficient markets any more. You’ve beaten it into us that there is money to be made out there. (Ed: also said with tongue only partly in cheek)

Efficient Capital’s Ernest Jaffarian on the benefits of managed accounts: “Sensible things that any trader would do in the markets - like adjusting allocations in response to rising volatility - can be executed with hedge funds as long as you have a managed account.”

Alpha Metrix’s Jon Stein on stereotypes of CTAs: “With all the growth in the managed futures industry, why do people still treat us like the crazy brother no one wants to talk about?”