Maverick Bian

Buy-and-Hold As Good As Hedge Funds?

It depends on how you define timing here. Statistically earnings from timing the markets, in our words, high frequency trading or very short-term trading with a high portfolio turnover, only represent 7% across the board, per one research source, which means for another 93% as a fund manager you need to take directional bets, more or less. Even for market neutral fund, they take some degree of directional bets on specific positions while on portfolio aggregate level they keep exposure to one designated benchmark almost to zero. Yet, if you were to test them with other benchmarks/risk factors, you might be surprised they in fact not market neutral in a strict sense, especially during a specific time window. Based on market efficiency theory, if you didn't take any risk, you're not supposes to have a return, let alone excess return(no-free lunch theory): that's why equity market neutral/arbitrage hedge funds across the board have been ranked almost on the bottom, compared to other HFRI indices during the past 3 to 5 years. However, they typically use a very large leverage, which increase other risk on other fronts and LTCM is a good example in this regard.

I looked into almost all timing funds including high-frequency, programming trading, volatility arbitrage, CTA, and the like, and I found most of PMs are former traders or programmers, options traders, futures, stock traders, currency traders, or trading oriented. They like to trade, in their words, “Since most of time orgasm only lasts for a couple of days, why should I hold it for months, and even years?” And most of time, they're running a very highly concentrated portfolio if they target an unbeatable return, except for program-trading and market-neutral funds. I have a friend who is totally a new horn on US stock markets: last year jumped in and have earned more than 1000% so far, compared to overall market return at 16% around. But the risk he has undertook is huge. Personally he may be a good trader, but he's far, far away from a good portfolio manager.

Typically for timing funds because they need to capture enough themes/catalysts to grow their portfolio fast, so capacity becomes a big issue for most funds in this category. And statistically more than 90% of traders cannot live longer than 5 years unless they can evolve themselves into a well-disciplined risk manager-esque. If Brian Hunter can disciple himself, Amaranth remains a shining star, I guess. If markets are so shallow and you put in so many orders/contracts, you're actually take on a huge risk of be manipulated by others as well as by counterparties. And if JPM could have released its billion-dollar collateral on Friday, and Amaranth would still have been alive; it’s huge sales pressure on Monday that declared the demise of Amaranth, due to the street “rumors”.

Is buy-and-hold a good strategy? I'm not sure, but if you're running a book with billions of dollars of buying power, you may have no choice but wait for big events like earning surprises or something, because every move you make will have a great effect on the underlying price. Based on my thorough research in the entire hedge fund world, I found most fantastic returns are most likely associated with funds during its every early start-up stage with AUM much less than $50mm. So, if you're not a large investor, a small boutique may give you a surprise from time to time. And if you were to move your comparison window starting from 1990 to 2001, you’ll get the totally different views on the hedge fund industry, I’m sure.

Still, statistical rules will not apply to a few individual case, so I would suggest you not care too much about the whole industry, only focus on how to improve your own portfolios, because based on some preliminary outcomes from Maverick 500 Hedge Funds Project, there still is enough room to grow your portfolios if you can pick those talented managers. Yet, if you're a pension fund manager like Calpers, I would suggest you go for an FoHFs since you have a specific mandate and need to feed myriads of retirees on a monthly basis while not dipping into the fund’s principal. Only pursing a high return on a few single-manager names is not a good way to go.

Just my 2 cents!

Maverick500