A New Stream for Hedge Fund Investors?

by: Cam Hui, CFA

The news of the demise of former CNBC anchor Ron Insana’s venture has been a catalyst for more questions about the hedge fund business model. Are these project returns persistent (also here)? Are there cheaper alternatives?

Looking for uncorrelated pure alphas
I have a modest proposal for hedge fund investors in light of these difficulties. The story of hedge fund investing has been to look for a pure alpha stream, however you want to define it, that is uncorrelated with the return pattern of existing asset classes.

If that’s the case, why not go into the gaming (or casino) business?

In the gaming business, the house has an edge in any game you play and takes steps to enforce that edge (e.g. tossing out the card counters at Blackjack, etc.) The customers know it, but they still keep coming.

Statistically, the return pattern of every game that a customer plays is uncorrelated with any other. The advantage of being in the gaming business means that you don’t have the problem of the shifting correlation problem: The return correlations of seemingly uncorrelated factors and asset classes converging to 1 during periods of financial crisis.

The main difference is the fee structure. In a hedge fund, you typically pay 2% and 20% with a lockup. In the gaming business, the lockup remains. However, there are significant overhead cost to keep the lights on in a gaming operation. However an investor can gain some of the benefits of economies of scale if there are such a venture can achieve sufficient size.