3 ms·

This shouldn't be too big of a surprise. Most academic research about hedge funds show that the majority of them don't outperform the market. When they do, it a

by travisp 14y ago

This shouldn't be too big of a surprise. Most academic research about hedge funds show that the majority of them don't outperform the market. When they do, it appears to be because of greater exposure to particular risk factors rather than manager skill (in investing, greater risk usually means greater potential for reward). When you consider the extra costs of investing in a hedge fund over investing in the market, most hedge fund investors are getting a bad deal -- they are paying more, but getting market returns. One source that looked at 12,980 hedge funds with $1.8 trillion in management: http://faculty.baruch.cuny.edu/tbali/BaliBrownCaglayanJFE2010.pdf http://faculty.baruch.cuny.edu/tbali/BaliBrownCaglayanJFE201...

wtvanhest 14y ago
Its possible that I am reading the paper incorrectly, but the conclusion clearly states that manager selection of Beta accounts for a large majority of over or under performance. Nowhere in the paper does it suggest that they do or do not under perform the market. To anyone who is familiar with how money management works, the conclusion in the paper is obvious. Exposure to beta will increase returns in good periods and decrease returns in bad periods. The research looking at "average hedge fund performance" is also misleading because while the analysis is technically correct, the conclusions in those papers are obvious as well. If you hedge out most of the beta, you will get zero return on average. Once you subtract expenses, you will by default perform negatively the market. (in reality, hedge funds do not hedge all beta to zero, they hedge it pretty close to 1 so they track the market, but they probably under track it. This also leads to negative alpha) Where hedge funds play a role in investment management is when individuals can select hedge fund managers they believe will outperform. Professional investors, including fund of funds believe they can do this, and some will do this, some won't and the total will net to less than zero. [[Added in response to additional point below]] The paper cited is using an econometrics model which is using factor analysis to determine where the "biggest" source of performance comes from. Because beta is a factor, it will overshadow alpha automatically if beta is large enough. Alpha between funds will be destroyed in the model so the model will output zero alpha with enough funds. While beta will be persistent since by definition beta is a performance magnifier (for lack of a better term.) In other words, the conclusion in the paper is obvious, and not worthy of discussion. [[Added in response to Jesse]] Yes, if you are aggregate all money invested in hedge funds the average return will be lower than the benchmark that Beta is based off of. ETFs may or may not beat the benchmark depending on the ETF. Some have tracking error which causes them to not beat benchmarks. Also, you may notice that I am not arguing whether the OP is correct, I am generally agreeing with them, but the point is that his assertion is obvious and the cited paper is obvious and provides no real value.
- travisp 14y ago
  Yes it's beta and yes it's what's expected, but the hedge fund industry has historically claimed that returns are coming from alpha (investor skill) rather than beta (riskiness). There's the claim now that they are picking the right kind of beta to attempt to justify what papers are finding, but the outperformance that is exhibited by some hedge fund managers doesn't usually persist, suggesting that their selection of the particular risks were not a result of their skill. If the returns are actually from "dumb" beta, then the hedge fund fees are not appropriate for what you're getting. You're getting market returns appropriate for the amount of risk that's being taken, rather than outperforming, and then losing most of that to fees. Yes, exposure to beta can be a smart choice, but it can be done without excessive fees. >Where hedge funds play a role in investment management is when individuals can select hedge fund managers they believe will outperform Yes, this is the common refrain in mutual funds too: Buy the top performing managers, not the average fund. But the research shows that hedge funds that outpeform do not persist in outperforming. This suggests that the managers are not being particularly skilled in their selection of risk. Most fund of funds do not perform significantly better either -- there's little evidence that hedge funds are providing investors real value. Hedge funds are a status symbol for the wealthy, not a smart investment.
- jessaustin 14y ago
  So, the average hedge fund investor will make less money in her hedge funds than she would have made in an ETF? I realize that there are benefits in diversification, but travisp is generally correct.
- travisp 14y ago
  I can't edit any more, but I thought it might be helpful to others if I add this: I'm not really disagreeing with you either: I agree that the conclusion of the paper is mostly obvious, but it's valuable because it is important to show that beta is overshadowing alpha significantly in hedge funds. I could be wrong, but I would be surprised to see top hedge fund managers claiming that their results come from beta, not alpha. If they did, it would be harder to justify the amount they are paid during periods of good performance. I also do think that some manager skill exists in all areas of the market to a limited and varied extent. But, I suspect that even the hedge fund managers who do "provide alpha" capture most of it with their fees, leaving their clients with market returns or worse.

by travisp 14y ago

wtvanhest 14y ago

Its possible that I am reading the paper incorrectly, but the conclusion clearly states that manager selection of Beta accounts for a large majority of over or under performance. Nowhere in the paper does it suggest that they do or do not under perform the market. To anyone who is familiar with how money management works, the conclusion in the paper is obvious. Exposure to beta will increase returns in good periods and decrease returns in bad periods. The research looking at "average hedge fund performance" is also misleading because while the analysis is technically correct, the conclusions in those papers are obvious as well. If you hedge out most of the beta, you will get zero return on average. Once you subtract expenses, you will by default perform negatively the market. (in reality, hedge funds do not hedge all beta to zero, they hedge it pretty close to 1 so they track the market, but they probably under track it. This also leads to negative alpha) Where hedge funds play a role in investment management is when individuals can select hedge fund managers they believe will outperform. Professional investors, including fund of funds believe they can do this, and some will do this, some won't and the total will net to less than zero. [[Added in response to additional point below]] The paper cited is using an econometrics model which is using factor analysis to determine where the "biggest" source of performance comes from. Because beta is a factor, it will overshadow alpha automatically if beta is large enough. Alpha between funds will be destroyed in the model so the model will output zero alpha with enough funds. While beta will be persistent since by definition beta is a performance magnifier (for lack of a better term.) In other words, the conclusion in the paper is obvious, and not worthy of discussion. [[Added in response to Jesse]] Yes, if you are aggregate all money invested in hedge funds the average return will be lower than the benchmark that Beta is based off of. ETFs may or may not beat the benchmark depending on the ETF. Some have tracking error which causes them to not beat benchmarks. Also, you may notice that I am not arguing whether the OP is correct, I am generally agreeing with them, but the point is that his assertion is obvious and the cited paper is obvious and provides no real value.

travisp 14y ago
Yes it's beta and yes it's what's expected, but the hedge fund industry has historically claimed that returns are coming from alpha (investor skill) rather than beta (riskiness). There's the claim now that they are picking the right kind of beta to attempt to justify what papers are finding, but the outperformance that is exhibited by some hedge fund managers doesn't usually persist, suggesting that their selection of the particular risks were not a result of their skill. If the returns are actually from "dumb" beta, then the hedge fund fees are not appropriate for what you're getting. You're getting market returns appropriate for the amount of risk that's being taken, rather than outperforming, and then losing most of that to fees. Yes, exposure to beta can be a smart choice, but it can be done without excessive fees. >Where hedge funds play a role in investment management is when individuals can select hedge fund managers they believe will outperform Yes, this is the common refrain in mutual funds too: Buy the top performing managers, not the average fund. But the research shows that hedge funds that outpeform do not persist in outperforming. This suggests that the managers are not being particularly skilled in their selection of risk. Most fund of funds do not perform significantly better either -- there's little evidence that hedge funds are providing investors real value. Hedge funds are a status symbol for the wealthy, not a smart investment.
jessaustin 14y ago
So, the average hedge fund investor will make less money in her hedge funds than she would have made in an ETF? I realize that there are benefits in diversification, but travisp is generally correct.
travisp 14y ago
I can't edit any more, but I thought it might be helpful to others if I add this: I'm not really disagreeing with you either: I agree that the conclusion of the paper is mostly obvious, but it's valuable because it is important to show that beta is overshadowing alpha significantly in hedge funds. I could be wrong, but I would be surprised to see top hedge fund managers claiming that their results come from beta, not alpha. If they did, it would be harder to justify the amount they are paid during periods of good performance. I also do think that some manager skill exists in all areas of the market to a limited and varied extent. But, I suspect that even the hedge fund managers who do "provide alpha" capture most of it with their fees, leaving their clients with market returns or worse.