While commentators today may blame hedge funds as the common source of the selling, this tendency for markets to move together as one has been on the global market scene for quite some time. Frankly, the source (or sources) of the global market shudder are irrelevant. What is somewhat surprising is that seemingly unrelated markets also moved down last week.

This pursuit of more exotic betas has been manifested in the rapid growth of the ETF marketplace. After fulfilling the style and sector needs of equities, the ETF providers have expanded into more exotic asset classes. A few years ago a commodity ETF was a pipe dream. Now they are quite commonplace. Today we have ETFs that follow even more exotic strategies like the so-called “carry trade” in currencies. However for some high-net worth investors and institutions these types of products are not exotic enough.

First Going Private discusses the overlap of hedge fund activists and private equity and how the interplay between the two could mean a much longer life for the private equity boom than that discussed by the many naysayers.

What happened? Energy prices cooled. The performance of commodities lagged the surging stock market and nearly every one who bought into the hype is now disappointed. Newly formed hedge funds that were launched to take advantage of the “inevitable” rise in commodity prices are now facing more sober times. It is perfectly natural to wonder whether to hold onto commodity funds that are now, in all likelihood, underwater.

"Flush with hundreds of billions of dollars, private equity firms are beginning to offer compensation on a previously unimaginable scale to the chief executives who run the once-public companies that the firms have bought out. At the privately held firms, the executives still get salaries and bonuses, but a crucial difference lies in the ownership positions they can secure, which can turn into particularly bountiful riches when these businesses are sold or go public again."

Loyal readers of Abnormal Returns will remember we have touched on this theme previously with posts on CEO cash and control and the Five C’s of private equity buyouts. While we do not believe entirely that:

On the last business day of the year we guess it is appropriate that two leading sources of financial news chose to publish stories on executive compensation. Julie Creswell in the New York Times reported on the way new executive hire pay packages have been structured so as to minimize the risk to the new executive.

Apparently that mentality continues on today. Jeff Matthews heard on a conference call a CEO state that his foremost goal in the new year was to meet “guidance.” Matthews continues on:

By looking at the top holdings of some top managers, investors can put together a best-ideas portfolio without paying management fees. Most of the largest and best-run hedge funds are closed to new investors, and even if they were to open their doors, fees can be steep. Hedge funds generally carry base management fees of at least one percentage point and typically take 20% or more of profits.

John Bethel at Controlled Greed weighs in on the article as well noting that this process of scanning the holdings of top managers is widespread among professional (and amateur) investors alike and is “… an excellent tool in finding investment opportunities.”

Investors should keep their eye out for companies who in their fear of a takeout offer look to leverage up their own balance sheets. They could borrow (cheaply) from the high yield debt markets to: buy another company, pay a significant special dividend, or buy back a slug of their own stock. All of these are tried-and-true methods to help scare off potential acquirors. This not to say that these types of moves will necessary be in the best interest of all shareholders, but they will certainly serve the purposes of management.

Capital

While the hedge fund wave continues apace, the KKR deal seems to have put a brake on the once seemingly inevitable wave of private equity offerings. Heather Timmons in the New York Times looks at how the structure and performance of the KKR deal has made it difficult for other firms to follow in their footsteps. High fees aside, the biggest complaint seems to be the somewhat muddled investment strategy for the fund. In contrast, Timmons notes that publicly traded hedge funds have, in a sense, a more transparent investment strategy.

We here at Abnormal Returns do not claim to be options experts, but the time is right to explore an interesting options-related opportunity. The stock market, measured by the S&P 500, has run up from a June low of some 1220 to a recent high of nearly 1390, for a gain of some 14%. With some valuation and technical measures becoming a bit overextended it should not come as surprise that some investors are looking to reduce their overall market exposure.

“Chicago used to be known as the hog butcher of the world. The city now will be known as the world’s risk manager,” said John F. Sandner, a Chicago Merc board member.

As we noted on Tuesday, the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (BOT) are combining with the Merc Exchange as acquirer. The deal was in the eyes of many inevitable and an infinitely logical combination. Given that what are the implications of the deal?

All About Alpha recaps a paper that looks at the question of how much alpha is truly available to investors in various hedge fund strategies. One of the conclusions drawn is that some of these returns are a function of so-called “hedge fund betas” or “exotic betas.” These are in a sense systematic returns not currently available in publicly traded investment vehicles.

The simple fact is that they are both. Given the diverse nature of strategies within the trillion dollar hedge fund industry, this should not be all that surprising. What changes from time-to-time is the public’s perception of hedge funds versus some prior reality. Often it takes a front page item to swing public perception from one extreme to another.

In the hedge fund realm it has been hypothesized that there is only a limited amount of “alpha” that can be captured by hedge funds. Logically if the hedge fund industry continues to grow that alpha will be spread ever more thinly. The question is the same for private equity as well. As more private equity firms raise ever larger funds, it begs the question of whether the pickings will become slim?

The Economist highlights how the fall in oil prices is raising questions in the minds of many about their long-only commodity investments. In addition to the drag of negative future rolls are having on returns, the broader case for commodities is thinner today.

Our goal here is not to tear down those who invest in or manage portfolios based on the (varying) principles of SRI. Everyone should feel free to invest in whatever manner their conscience directs them. However, socially responsible investors should also be aware that their strategy is inherently compromised.

Tom Lauricella in the Wall Street Journal (sub. req.) reports that WisdomTree has hired former SEC chairman, Arthur Levitt as a “senior adviser.” The surge in the number of ETFs, including those that are more narrowly defined has created a need for additional marketing firepower.