Risky but some still bet on beta – the unskilled returns from asset classes. I prefer alpha – absolute returns from market skill. There is no need for retirement savings and personal net worth to suffer the unreliability and volatility of long only stocks and bonds. Could individual and institutional investors afford another severe bear market? Safer alternatives and better uses of capital are available. The ONLY financial certainty over the next five years is a substantial increase in investment in hedge funds. Don’t let the beta behemoths crush your portfolio, again.

Since inception here are the 10 most popular Hedge Fund Blog posts.

Hedge fund blog? I wrote this just after arriving in New Zealand for some meetings. While long only passive and active funds extol their virtues, investors should remember the ONLY reason to hire any manager is for absolute returns. Relative return funds emerged out of “Modern” Portfolio Theory. Managers were asked to beat a benchmark NOT make money! To add insult to injury, managers became obliged to fully invest regardless of market conditions or valuation. Asset allocation meant risk management was “unnecessary”! Evaluate products for their return on risk and alignment of SHARED interests with clients. Don’t get caught out by tail risk. Hedge black swan and purple sheep “rare” events.

Hedge fund test? In the REAL world, paper qualifications don’t help much. A PhD in finance is not a PhD in making money. Spend 50 years theorizing in the Ivy League but 50 days on a trading floor delivers the true financial education. Economics Nobel prize winners are infamously negatively correlated with investment acumen and financial expertise. Random walk models, mean-variance “optimization” and CAPM have not aided investors that need consistent returns. Check out the performance of traditional portfolios following ivory tower “advice” and groupthink policy asset allocation. It hasn’t worked and it won’t work. Short FNGN and ENV?

Private equity IPO? I don’t usually write about specific securities or mispricing opportunities since this is a free blog and it would be unfair to investors to give away proprietary information. But the hyperbole and paradox of PRIVATE equity firms going PUBLIC at ludicrous valuations was a short sell that couldn’t be missed. And some say liquid equity markets are efficient! It is rare to short sell the high (IPO time) and cover at the low (December 2008) but sometimes the harder you work the luckier you get. Shorting doesn’t cause securities to go down of course; that happened when the market figured out the true value of FIG and BX. The insiders were smart people; why buy when they were selling?

Rich enough for hedge funds? Retail hedge funds. Absolute return strategies on 401(k) menu options? Why can’t investors of ANY net worth be allowed to invest in skill-based strategies? In a few countries they can but in many they still can’t. UCITS may help in some geographies. There is no correlation between being an accredited investor and being a sophisticated one. Whether you have $1 trillion or $1,000 to put to work, everyone needs as much alpha and strategy diversification as possible. The regulatory wealth test seems incompatible with personal freedom. Why “protect” Mom and Pop from products that perform and diversify portfolios? Or is it actually to protect “passive” pushers?

Jack Bogle versus hedge funds? Jack Bogle is brilliant. A brilliant salesman of BELIEFS but the index crowd didn’t like being confronted with the FACTS. Today, another 3 years on, stock benchmarks are even lower and bonds don’t pay enough yield. While the S&P 500 has lost money, some component stocks dropped -100% whereas others have risen massively like AAPL, GOOG, PCLN, ISRG and CRM. Equities are opportunity sets for long/short alpha capture NOT buy and hope beta. Security selection can’t be done? Market timing is impossible? Hold all stocks regardless of price or prospects? George Soros, Warren Buffett and Jim Simons were just lucky flukes? 3,000 hedge funds making money in 2008 wouldn’t have helped cushion the crash for Bogleheads? There are no arbitrages?

Hedge fund arbitrage? Those dollar bills are still being dropped on streets all over the world and being scooped up by the quick and nimble. Why take unhedged directional risk when the markets offer up so many inefficiencies and arbitrages. The experts hate this notion because it goes against the house of cards theory that no securities are ever mispriced and arbitrages cannot appear. Risk and return have no connection. Some arbitrages offer a good return for very low risk. Meanwhile long only funds in major stock markets have delivered negative returns on very high risk. Finding lucrative arbitrages does take talent and expertise. Fortunately this is available for the LOW fees of 2 and 20.

2 and 20? Skill costs in all business sectors. With good hedge funds, the after fee return to investors is higher than traditional products. Paying a few basis points for -50% losses isn’t cheap. Many long only funds have 90% of returns explained by the benchmark. So the residual 10% explained by active management “justifies” a 1% expense fee? The IMPLIED expense fee for many traditional funds is nearly 10% even during negative returns since index tracking costs almost nothing. The 2% management fee and 20% of new profits for a good hedge fund is a bargain by comparison. All alpha strategies are capacity constrained and in most cases the 2% is NOT a profit center. The more clients make the better “pay” for the manager. Incentives work. Check out the returns of funds that DON’T charge incentive fees.

Portable alpha? Don’t add alpha to beta. Get rid of the beta and isolate the alpha. The portable alpha fad was weird. Now thoroughly discredited I’ve always advised any institution that asked against this crazy concept. Why waste alpha by “porting” it back onto a beta. It nullified the absolute returns of hedge funds by transforming it into relative returns! Shocking that it ever got traction but some promote it even today. As we saw in 2002 and 2008 and will again soon don’t let beta drown the alpha. Strip out beta factor exposures by shorting derivatives and ONLY invest in alpha. Strategy alpha diversification not strategic beta asset allocation is the way to go.

Hedge fund quant? Curiously quant hedge funds are reviled even more than non-quant strategies. Even some hedge fund investors won’t go near systematic trading. Bizarre considering the outperformance and diversification benefits. Almost everything has been blamed recently on a “new” quant strategy – high frequency trading. Humans are slow at large data set analysis, complex event processing and trade execution, so faith in only carbon-based managers seems quaint. The “random” markets are full of anomalies and computational intelligence is often the first to spot them. Anyone that avoids quantitative strategies does not have a diversified portfolio. Why ignore NEW ways of making money and reducing risk?

Hedge fund definition? Uncorrelated? One of the problems with the “hedge fund” industry is that it is not rigorously defined and only a subset actually are hedge funds. The number of GOOD hedge funds is even less. As a rule of thumb I have found that 80% of “hedge funds” are unsuitable. Thorough manager due diligence, heavy qualitative and quantitative analysis permits the separation of the skilled from the lucky. Skill persists, luck runs out. Managers that make money in up markets and lose it in down markets are running mutual funds NOT hedge funds. Fortunately there are currently over 2,000 open hedge funds globally that do have skill. And the number grows every month.

Writing a blog on investing defensively rather than conventional “wisdom” has been interesting. Hopeless hypotheses and industry inertia stop many investors from being allowed to access better risk-adjusted returns. Hedging, strategy evaluation and manager due diligence require specialist expertise but it’s cheaper than the damage wrought by “simple” portfolio construction. I don’t know how much longer ideas like “strategic asset allocation” and “time in the market” will exist. I do know that sophisticated investors accept that radical surgery and portfolio triage are required if performance is to be achieved over the long term, irrespective of the economy.

The tipping point from beta-centric to alpha-centric portfolios is here. Most mainstream commentary on hedge funds is uninformed and therefore negative. Those who criticise hedge funds have never invested in one. Few that take the time to understand skill-based absolute return strategies revert back to long only. Other industries embrace innovation but improvements in investment technology are still fiercely and often successfully resisted. Sad for those that urgently need access to new sources of return. Whether the Dow is on its way to 50,000 or 500, the future growth of the hedge fund industry is guaranteed.

by Veryan Allen. Copyright

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“As of this past Friday, the SEC now has greater ability to extract information from employees of corporations and others involved with those employees.” Ed Tomko, head of the White Collar Crime practice at Curran Tomko Tarski, announced.

On Friday, a payment was made by the SEC to Karen and Glen Kaiser who provided documents that helped the SEC build its case against Arthur J. Samberg, founder of the Pequot hedge fund and David E. Zilkha, a former Microsoft employee.

“This has broad reaching implications for public companies as well as businesses operating in the financial sectors,” said Tomko. “This is the largest amount awarded by the SEC to whistleblowers in an insider-trading case.”

As a result, there is the potential now for whistleblowers to be enticed by lucrative fees they will receive for providing information to the government. This can become a slippery slope for businesses. This can now provide possibly a powerful incentive for an employee or individual related to an employee who know of a securities violation to contact the SEC and provide information that may lead to a large payment in exchange for the information.

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Some investors still bet on beta – the unskilled returns from asset classes. I prefer alpha – absolute returns from market skill. There is no need for retirement savings and personal net worth to suffer the unreliability and volatility of long only stocks and bonds. Could individual and institutional investors afford another severe bear market? Safer alternatives and better uses of capital are available. The ONLY financial certainty over the next five years is a substantial increase in investment in hedge funds. Slay the beta behemoth.

Since inception in 2005 here are the top 10 most read Hedge Fund Blog posts.

1. Hedge fund blog? I wrote this just after arriving in New Zealand for some meetings. While long only passive and active funds extol their virtues, investors should remember the ONLY reason to hire any manager is for absolute returns. Relative return funds emerged out of “Modern” Portfolio Theory. Managers were asked to beat a benchmark NOT make money! To add insult to injury, managers became obliged to fully invest regardless of market conditions or valuation. Asset allocation meant hedging and risk management were “unnecessary”. Evaluate products for their return on risk and alignment of interests with clients. Don’t get caught out by tail risk. Hedge black swan and purple sheep “rare” events.

2. Hedge fund test? In the REAL investment world, passing paper tests doesn’t help much. Spend 50 years theorising in the Ivy League but 50 minutes on a trading floor delivers the true education. Economics Nobel prize winners are famously negatively correlated with investment success. Efficient markets, mean-variance “optimization” and CAPM have not aided investors that desire consistent returns. Check out the performance of traditional portfolios following ivory tower “advice” and groupthink policy asset allocation. It hasn’t worked and it won’t work. Short FNGN and ENV?

3. Hedge fund quant? Curiously quant hedge funds are reviled even more than non-quant strategies. Even some hedge fund investors won’t go near systematic trading. Bizarre considering the outperformance and diversification benefits. Almost everything has been blamed recently on a “new” quant strategy – high frequency trading. Humans are slow at data analysis, complex event processing and trade execution, so faith in only carbon-based managers seems quaint. The “random” markets are full of anomalies and computational intelligence is often the first to spot them. Anyone that avoids quantitative strategies does not have a diversified portfolio. Why ignore NEW ways of making money and reducing risk?

4. Jack Bogle versus hedge funds? Jack Bogle is brilliant. A brilliant salesman of BELIEFS but the index crowd doesn’t like being confronted with the FACTS of humble arithmetic. Today, another 3 years on, stock benchmarks are even lower and “passive” bond funds don’t pay enough yield. While the S&P 500 has lost money, some component stocks dropped -100% but others have risen massively like AAPL, GOOG, PCLN, ISRG and CRM. Equities are opportunity sets for long/short alpha NOT buy and hope beta. Security selection can’t be done? Market timing is impossible so hold all stocks regardless of prospects? George Soros, Warren Buffett and Jim Simons were just lucky flukes? 3,000 hedge funds making money in 2008 wouldn’t have helped cushion the crash for Boglehead portfolios?

5. Hedge fund arbitrage? Those dollar bills are still being dropped on streets all over the world and being scooped up. Why take unhedged directional risk when the markets offer up so many inefficiencies and arbitrages. The experts hate this notion because it goes against the whole house of cards theory that no securities are ever mispriced and arbitrages cannot appear. Risk and return have no connection. Some arbitrages offer a good return for very low risk. Meanwhile index funds in major stock markets have delivered negative returns on very high risk. Finding lucrative arbitrages does take talent and expertise. Fortunately this is available for the fee of 2 and 20.

6. 2 and 20? Skill costs in all business sectors. With good hedge funds, the after fee return to investors is higher than competing products. Paying a few basis points for -50% losses isn’t cheap. Many long only funds have 90% of performance explained by the benchmark. So the residual 10% explained by active management “justifies” a 1% expense fee? The IMPLIED expense fee for many traditional funds is nearly 10% even during negative returns since index tracking costs almost nothing. The 2% management fee and 20% of new profits for a good hedge fund is a bargain by comparison. All alpha strategies are capacity constrained and in most cases the 2% is NOT a profit center. The more clients make the better “pay” for the manager. Incentives work. Check out the returns of funds that DON’T charge incentive fees.

7. Private equity IPO? I don’t usually write about specific securities or mispricing opportunities since this is a free blog and it would be unfair to investors to give away proprietary information. But the hyperbole and paradox of PRIVATE equity firms going PUBLIC at ludicrous valuations was a short opportunity that couldn’t be missed. And some say the markets are efficient! It is rare to short sell the high (IPO time) and cover at the low (December 2008) but sometimes the harder you work the luckier you get. Shorting doesn’t cause securities to go down of course; that happened when the market figured out the true value of FIG and BX. The insiders were smart people; why buy when they were selling?

8. Rich enough for hedge funds? Retail hedge funds. Absolute return strategies on 401(k) menu options? Why can’t investors of ANY net worth be allowed to invest in skill-based strategies? In a few countries they can but in many they still can’t. UCITS may help in some geographies. There is no correlation between being an accredited investor and being a sophisticated one. Whether you have $1 trillion or $1,000 to put to work, everyone needs as much alpha and strategy diversification as possible. The regulatory wealth test seems incompatible with personal freedom. Why “protect” Mom and Pop from products that perform?

9. Portable alpha? Don’t add alpha to beta. Get rid of the beta and isolate the alpha. Very strange was the portable alpha fad. Now thoroughly discredited I’ve always advised anyone that asked against this crazy concept. Why waste alpha by “porting” it back onto a beta. It nullified the absolute returns of hedge funds by transforming it into relative returns! Shocking that it ever got traction and some promote it even today. As we saw in 2002 and 2008 and will again soon don’t let beta drown the alpha. Strip out beta factor exposures and ONLY invest in alpha. Strategy alpha diversification not strategic beta asset allocation is the way to go.

10. Hedge fund definition? Uncorrelated? One of the problems with the “hedge fund” industry is that only a subset actually are hedge funds. The number of GOOD hedge funds is even less. As a rule of thumb I have found that 80% of “hedge funds” are unsuitable. Thorough manager due diligence, heavy qualitative and quantitative analysis permits the separation of the skilled from the lucky. Skill persists, luck runs out. Managers that make money in up markets and loses it in down markets are running mutual funds NOT hedge funds. Fortunately there are currently over 2,000 open hedge funds globally that do have skill. And the number grows every month.

Writing a blog on investing defensively rather than conventional “wisdom” has been interesting. Hopeless hypotheses and industry inertia stop many investors from being allowed to access better risk-adjusted returns. Hedging, strategy evaluation and manager due diligence require specialist expertise but it’s cheaper than the damage wrought by “simple” portfolio construction. I don’t know how much longer ideas like “strategic asset allocation” and “time in the market” will exist. I do know that sophisticated investors accept that radical surgery and portfolio triage are required if performance is to be achieved over the long term, irrespective of the economy. The tipping point from beta-centric to alpha-centric portfolios is here.

Most mainstream commentary on hedge funds is uninformed and therefore negative. Those who criticise hedge funds have never invested in one. Few that take the time to understand skill-based absolute return strategies revert back to long only. Other industries embrace innovation but improvements in investment technology are still fiercely and often successfully resisted. Sad for those that urgently need access to new sources of return. Whether the Dow is on its way to 50,000 or 500, the future growth of the hedge fund industry is guaranteed.

by Veryan Allen. Copyright

Go to Source