Lots of chatter lately about endowments puking up their private equity portfolios. (And interesting companies popping up to facilitate private transactions like Sharespost and SecondMarket.)

I always wondered why big investors of private equity (like the endowments and pension funds) don’t hedge their portfolio at all? If they assume that they are top quartile, which they have to assume because otherwise they should be buying SPY and QQQQ, then they are assuming they’re generating alpha returns. So why not hedge out some of that risk through a static, or better, dynamic hedge? Hedging against long bear markets is a great idea because not only are their holdings going down in value, but their exits disappear. Anyways, ping me if anyone does this; I’d like to chat with them. Is there such a thing as a market-neutral private equity investor?

Apple (AAPL) announced a great quarter and was up almost $9 Tuesday to nearly $200, an all time high. Visa (V) and MasterCard (MA) are also at 52-week highs (Julian Robertson just mentioned he still likes them at the recent VIC conference). Why do we mention these three stocks?

These three stocks are the top three most popular stocks in the World Beta clone. If you are a long time blog reader you know what that this, if not, a little background…

The financial media has been all over the recent Galleon insider trading case (WSJ, ClusterStock, Fortune, HuffPo, etc).

I’m actually a little surprised we don’t see more insider trading allegations – most of the hedge fund industry is built around information arbitrage. I remember reading one of Cramer’s first books and thinking, 'wait, isn’t how he makes most of his money simply insider trading?' There is a ton of grey area here, and entire businesses built around expert networks to deliver that info.

“You don’t want to be average; it’s not worth it, does nothing. In fact, it’s less that the market. The question is, ‘How do you get to be first quartile?’ If you can’t, it doesn’t matter what the optimizer says about asset allocation.” – Dr. Allan Bufferd, CIO of the MIT endowment in Foundation and Endowment Investing.

While Dr. Bufferd was talking about investing in private equity, the same applies to hedge funds as well. (We have two extensive chapters on the topic in my book.) I wanted to chat a bit about hedge funds, and then more specifically hedge fund clones. I have written a bunch of articles on hedge fund indexing and replication in the past, and there has been a lot of chatter recently about hedge fund clones:

Draw your own conclusions on endowment performance last year, fiscal year ending June 30th. Below are facts.

Bonds +7%

There is a ton of good information in this quarterly report (link to PDF here, or in full at the bottom of this post). Goldman looks at 687 funds with $500 billion in long stock positions. Similar to a lot of what we do on AlphaClone.

They examine a few strategies that historically outperform the S&P 500. The first is a strategy of buying the 20 most concentrated stocks (defined as hedge funds owning X% of the company). This has beaten the market by 14% a year since 2001. The 20 current stocks are:

by Maz Jadallah

The leaderboard makes it easy to rank our entire clone universe based on criteria you define. Want the best performing single fund clones over a five year period based on sharpe ratio? It takes seconds to get at that list.

Great interview with Bruce Berkowitz and Steve Forbes [HT: BA]. Fantastic discussion about holding a concentrated portfolio of stocks. I thought I would spend a little time updating some of the 13F hedge fund portfolios since rebalance was last Friday.

The first three funds as well as the combo fund (FOF) are mentioned in my book The Ivy Portfolio.

I don’t watch CNBC much, but was watching this AM over coffee at the house. I keep hearing people state, “I’m waiting for a pullback”, “This market is overbought”…reminds me of a little Jack Johnson for the wknd (below). It seems when everyone is talking about a pullback there is more room to the upside, and only when everyone is talking about buying is it time for a correction. Just a Friday missive.

PS Everything I do is quant (or quant with control over the dials), but for some reason nearly investor I meet with ends our conversation with:

by Maz Jadallah

Maverick Capital was formed in 1993 with $38MM when Sam Wyly hired Lee Ainslie away from Julian Robertson’s Tiger Management. By 1995 Ainslie was running the entire portfolio and in January 1997 he bought out the majority interest in the firm. As in the style of Tiger, Maverick is a long/short stock-picking equity fund based strictly on fundamental analysis. Ainslie’s goal is to “know more about every one of the companies in which we invest than any non-insider does.” As he learned from Robertson, one of his favorite metrics is comparing enterprise value to sustainable free cash flow. While Ainslie is the leader and face of the firm, he views his management team as peers and values the team culture at Maverick.

Before we built AlphaClone, I recall having a conversation with a big fund of funds manager (FOF). He stated that he liked the concept in theory, but had one reservation. From his experience, the top holding, as measured by the % of portfolio, was NOT the manager's best idea. He argued that this position likely got to this point by default - it simply was likely one of the top performing stocks and thus grew to take up a larger part of the portfolio (somewhat resembling a market cap weighted index).

I had mixed feelings about the analysis - I countered that if a manager didn't like the idea, there was no way he would let it dominate the portfolio in size. But, as always, I was willing to defer my opinion and let the data speak for itself.

In my last post I examined the performance of the endowments (estimated) versus some publicly traded asset classes, allocations, and tactical models. Below I am going to expand a bit and see exactly what a difference this past year made.

Every reporter has been all over the story including Barron’s , WSJ , Vanity Fair, and Bloomberg – although NONE have mentioned my book. That is a bit frustrating, but to be expected. It is a better story to talk about how much money these endowments have lost rather than review or mention a slightly academic book (with lots of data and tables) that would have shielded investors from the bear markets.

Chris Shumway is the portfolio manager of Shumway Capital Partners. Shumway was the #2 to Julian Robertson at Tiger Management before leaving to start his own fund in 2001.

Trained in the classical long / short style of Tiger, Shumway is a great fund to investigate for cloning. We thought it might be even more instructive to compare a simple clone to the underlying fund's returns.

by Maz Jadallah

A couple of days ago one of our favorite financial reporters, Greg Zuckerman, was being interviewed on CNBC regarding a story he had written for WSJ called “Picks & Pans From Market Pros”. Zuckerman had recently interviewed a handful of hedge fund managers for their investment ideas including George Soros (Soros Fund Management), John Paulson (Paulson & Co.) and Alan Fournier (Pennant Capital) and was reporting on where those investors were currently making their bets.

by Maz Jadallah

This week the latest hedge fund performance results were released. The New York Times blogged about this year’s performance numbers under the header “For Hedge Funds, Best First Half in 10 Years”. Indeed, according to Hedge Fund Research, hedge funds returned an average of 9.73 percent in returns year to date through June 24.