Hedge Fund Replication: Thoughts From the 'Engine Room'

by: Christopher Holt

A senior executive with a multi-billion dollar hedge fund firm writes us with reflections on last week’s “Hedge Fund Replication and Alternative Beta” conference in London.

Dear (Alpha Male),

…a few thoughts regarding the wonderful world of replication:

1) Just what is being replicated? My understanding - limited so far - is that Fung, Hsieh, Kat, et al are modelling HF returns net of fees. The utility to the end investor will be the same as if they were paying large fees to a hedge fund manager. The saving on fees does not lead to higher returns to the investor. This has been conveniently overlooked.

2) Why all managers should embrace the cloning: We have a problem demonstrating our skill (alpha) to investors. Skill is not the same as performance. The ‘clones’ / ‘replicated indices’ / ’simple models’ / ‘call-them-what-you-will’ will give us a common benchmark to measure our skill against. There is a large dispersion of ability in the manager universe. A benchmark will allow good alpha generating managers to differentiate themselves from bad managers. This should be a positive thing for good managers, all investors & bad managers (who can find gainful and fulfilling employment elsewhere!).

3) Is this anything new? No, in any industry the niche product is expensive and the “off-the-shelf-product” is cheap. Also, in any industry the niche product becomes mass produced if there is a demand for it. Finance is no different form any other industry. The sooner we realise this the better! The niche products of 10 years ago are becoming the “off-the-shelf” of today. This is a good thing. Alpha is about the innovation tomorrow rather than the implementation of yesterday. Again, I believe the replication discussion is good for the industry. It will encourage alpha innovation and development rather than product innovation and marketing!

Just a few random thoughts from someone in the engine room…

Like many people who contact us with tips and opinions, this individual prefers to remain anonymous. And that’s fine with us. In fact, if you’d like to voice an opinion or give us a tip, don’t hesitate to contact Alpha Male at AlphaMale(at)AllAboutAlpha(dot)com