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Deporting Alpha?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
Reuters reports that Massachusetts state fund drops four hedge fund firms:
Massachusetts will remove $1.6 billion from hedge fund managers Blackstone,
Crestline, EIM Management, and Strategic Investment Group as it shifts
its investment strategy after suffering recent heavy losses.
Trustees for the roughly $40 billion fund voted on Tuesday to pull out
of four firms that used portable alpha, a once popular technique
employed by pension funds to beat markets that underperformed during
the financial crisis.
"This is a strategic shift and not a dissatisfaction with the
individual managers," said the pension fund's chief investment officer,
Stanley Mavromates.
The
move comes at a time many big investors -- ranging from endowments to
pension funds -- are rethinking their strategies after a brutal year
where some trustees said they lost their taste for riskier investments.
Betting
on portable alpha backfired badly for Massachusetts, costing the fund
46 percent during the year that ended on June 30. Massachusetts had
long ranked among the best performing public pension funds.
The fund's trustees voted in August to scrap use of the strategy, but only decided on Tuesday which managers would be let go.
The state will likely have to wait until 2010 to get its money back.
Many hedge fund managers, unlike mutual fund managers, return
investments only periodically.
Mavromates said most funds should be back by the middle of 2010 and all will be returned by the end of next year.
Blackstone is expected to return $200 million while EIM will give back
$172 million. Crestline will return $670 million and Strategic
Investment Group will return $650 million, Mavromates said.
STATE STICKS WITH SOME HEDGE FUNDS
Even though Massachusetts, one of the first state pension funds to bet
big on hedge funds, is abandoning portable alpha, it is sticking with
loosely regulated portfolios and even plans to increase the amount of
money it allocates to them by the middle of next year.
Since making its first bet on hedge funds five years ago, the state
fund has seen an annualized return of 4 percent from those funds, far
more than the 1 percent return delivered by the Standard & Poors
500 index during the same time.
"We are $1 billion better off because we bet on hedge funds," Mavromates said.
Massachusetts
had allocated 5 percent directly with hedge funds and had a 6 percent
portable alpha investment, for a total of 11 percent earmarked for
absolute return strategies. Now the fund will allocate 8 percent to
alternative strategies.
By the middle of 2010, Mavromates said the pension fund will have $3.2
billion in hedge funds, up from the $2 billion it has in right now.
Most
of the money coming out of the portable alpha program will be
redistributed among Arden Asset Management, K2 Advisors, Pacific
Alternative Asset Management Company, Rock Creek Group and Grosvenor
Capital.
The hedge
fund of funds groups Arden, K2, PAAMCO and Rock Creek were among the
firms that helped the state select which hedge funds to invest with.
After the chaos of the past few years, Mavromates is imposing new controls on these managers as well.
"Each manager will be more focused," he said. "They will have tighter
guidelines that will play to their strengths." For example Rock Creek
with be asked to focus exclusively on non-U.S. investment strategies.
Mass PRIM isn't the only pension fund that got hit from portable alpha activities. FierceFinance reports that CalPERS also suffered from portable alpha woes:
It's
been a dismal year for pension giant CalPERS. The fund lagged the
Wilshire large public fund universe median return by six percentage
points for the 12 months that ended June 30, reports Pensions & Investments Online.
The
culprit seems to be the "beta overlay" on its near $6 billion Risk
Managed Absolute Return Strategies portfolio. The overlay seems to be
an attempt to attain portable alpha-like gains to goose returns in
order to align the overall portfolio with a more appropriate index, one
that includes hedge funds' returns.
The effort was apparently
managed internally, but it backfired miserably in the face of the
global markets swoon. The effort began in May 2008, the article notes,
and was compounded by a decision to go long in futures--which also
backfired.
At the beginning of October, Giovani Legorano wrote an article for Global Pensions, Rethinking the approach to portable alpha and ended it off by stating:
Several
industry figures also emphasised the ability of these strategies to
provide diversification benefits to a plan’s portfolio. However, they
also warned about the liquidity risk it might be associated with them.
Callin
said: “Liquidity is a crucial component to a successful portable alpha
approach, because while you are gaining asset exposure up front and not
paying for it, if that asset value declines because of the way
derivatives work investors will have to pay for the market decline. In
other words, the collateral cost. Therefore you need to have that
liquidity in your underlying strategy, in order to meet those margin
calls – cash calls – when the market declines. We believe that
appropriate liquidity management is a fundamental criterion of any
portable alpha approach.”
Callin is absolutely
right and one of the fundamental reasons why portable alpha strategies
got trounced in 2008 was because fiduciaries underestimated liquidity
risk of the underlying hedge fund strategies.
If Mass. PRIM was
invested in liquid hedge fund strategies in their portable alpha
portfolio, they wouldn't have been hit as hard and they wouldn't have
to wait as long now that they're redeeming those funds. The liquidity
mismatch cost them in 2008.
While portable alpha is
theoretically appealing - beta is cheap so swap into equity and bond
indexes and use the cash to invest in hedge funds that produce alpha -
in practice it can turn out to be a nightmare, especially
during a liquidity crisis.
How widespread is portable alpha
among global pension funds? Nobody really knows but there are trillions
in swaps underlying these portable alpha strategies. If counterparty
risk ever exploded again, you'd need another mammoth bailout to make
sure the pension system doesn't crumble.
[Note:
I wouldn't worry but some have privately expressed serious concerns
about pensions engaging in portable alpha and how it is yet another
time bomb that can potentially derail the global financial system.]
But
hedge funds are performing well this year so there are no immediate
concerns on the portable alpha front. Pensions & Investments
reports that hedge funds produced positive returns for the seventh consecutive month in September,
but none of the major hedge fund indexes outperformed the S&P 500’s
3.73% return or the MSCI World’s 4.61% return for the month. No
surprise there since hedge funds also have short positions so their
gains are capped when markets are trending up.
According to the NYT's DealBook, the big hedge funds posted gains in September:
- Moore Global Investments: +3.8 percent in Sept., +17.8 percent YTD
- Paulson Advantage: +0.48 percent in Sept., +13.2 percent YTD
- Capital Fund Management (CFM Stratus Fund 2x): +6.29 percent in Sept., +38.42 percent YTD
- Tewksbury Investment Fund: +1.1 percent in Sept., +12.36 percent YTD
- S.A.C. Capital International: +2.47 percent in Sept, +23.38 percent YTD
- Winton Capital Management (Winton Futures Fund): +2.85 percent in Sept, -5.5 percent YTD
- Tudor Investment Corporation (Tudor BVI Global Fund): +3.21 percent in Sept., +16 percent YTD
- Balyasny Asset Management: +0.79 percent in Sept., +5.85 percent YTD
- D.E. Shaw Oculus Fund: +0.4 percent in Sept., +10.2 percent YTD
- D.E. Shaw Composite International: +1.1 percent in Sept., +18.1 percent YTD
- Citadel Kensington Global Strategies Fund: +4.33 percent in Sept., +57.02 percent YTD
- Caxton Global Investment Fund: +1.7 percent in Sept., +5.65 percent YTD
- Serengeti Overseas Ltd: +5.3 percent in Sept., +67.9 percent YTD
- Tremblant Partners: +1.08 percent in Sept., +25.76 percent YTD
- Brevan Howard Fund: +1.42 percent in Sept., +16.15 percent YTD
These are impressive gains from top hedge funds but I wonder, how much of this is "true alpha" and how much of this is "disguised beta"? I suspect it's more of the latter.
You
might be saying who cares? After all, money is money and the bottom
line is they're producing strong returns. But when you're paying 2
& 20 to some hedge fund, you better make sure they're delivering
true alpha or else you're overpaying for what is essentially leveraged
beta. And that can come back to bite you when markets tank again.
Finally, Chris Holt, founder and editor of AllAboutAlpha, wrote on alpha being airlifted out of dying portable alpha strategies. I highly recommend you read it, including John Wartman's comment at the bottom of the page:
The
beta component of a portable alpha strategy should have been recognized
as leverage. The alpha component, usually a Fund of Hedge Funds, did
better than the beta component but failed to adequately protect the
downside, losing 15 to 20%. The idea of combining the strategies in
portable alpha was a creation of misdirected “rocket scientists” whose
mandate was to sell product. Any risk system or stress testing would
have shown the compound loss potential due to the leverage.
Compound
loss potential due to leverage? You don't say! That should be a topic
of discussion in the trial of the two former Bear Stearns hedge fund
managers that just got underway today. That, and outright fraud, of course.
»
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The pay-off from absolute return strategies is correctly stated to have a liquidity requirement. The same liqudity requirement applies to commodity futures arb funds that are now investing cash in tbills not ABS. Portable alpha is a fine concept, with cash backing of a maintainable estimated max draw down of (not the 50% market drop we saw) around 25%. What blocked the success was the lack of the sposoring schemes ability to borrow to fund drawdowns using the (falling price) assets as security. What is required is a guaranteed return from those who take risk. So in the case of say hedge funds, there are no fees, but a guaranteed return/borrowing cost of LIBOR +5% or lower depending on the ability of the manager to deliver performance. This is the blur, a company in the real world has to borrow at LIBOR plus and takes fees in the form of salaries. The 2+20 hedge fund borrows at a floating rate with no floor AND charges 2% minimum. I say, force hedge funds to borrow money and take zero from investors and instead make them list on the stock exchange.
They will get fucked on the other Greeks, especially gamma (ie delta) and vega (vol), but since this game is mostly alpha and beta that will be disregarded until the shit hits the fan. It will partly be implied since much of their stuff is illiquid and/or will be illiquid when vega turns up.
Make that: They will get fucked by the other Greeks, hahaha!
"These are impressive gains from top hedge funds but I wonder, how much of this is "true alpha" and how much of this is "disguised beta"? I suspect it's more of the latter."
No doubt. We had some people come in and pitch their private fund (which shall remain nameless) a few weeks ago. Hilarity! A bunch of statistics were used, but Sharpe ratio was conveniently omitted. I did a quick calculation during the meeting, and their risk-adjusted returns put them in the bottom 20% percent; they were near the top in terms of raw YTD performance.
To add insult to injury they consider themselves value-oriented and that they don't chase performance. Yet, right after they mention this, they presented their portfolio layout for several years, and in middle of 2007 they had 50% in Mortgage Backed Securities! I could barely contain myself from laughing in their faces. Even worse was they actually had CFA's and were senior management, and not just sales reps for the fund. Sadly, most people listen to these fools, and then proceed to fork money over into their fund.
Daedal,
Sad but so true! These guys were insulting your intelligence. Reminds me of a hedge fund clown who was boasting about his "super high Sharpe ratio". He was basically selling puts on the SPX, which works well in up markets but can easily wipe you out when the markets tank. Amazingly, this "hedge fund manager" was able to garner assets from institutions. They should have all been fired for investing with that clown.
the Bear case will be interesting...might Cioffi be first in line to be judged & serve time in this big shithole debacle ??
"these 2 MBS funds are fine...i just need to move a little personal money away for 'diversification'"
Don't get me started on mutual funds and their MERs....biggest scam on earth!!!!
How about the guys who use the S&P as a benchmark for performance. Why did I pay a manager to track the S&P when I could have just bought SPY? Certainly not for their market timing advice.
So,
to properly invest in a hedge fund I have to call the market direction. Then pay 2/20 for the implementation of the details to see that the masters of the universe underperformed the index.
Simple buying gold yielded 22.5% YTD without performance fees.
(12/31/08 gold London: 865$, spot now 1060$ YTD 22.5%)
The performance - especially after fees - is not that impressive.
Deport alpha, Import omega. Deport risk, import reward, deport repsonsibility, import trust. It's like a magic box of iniquity.