Hedge Fund Alpha is Negative; Down Around 1700 BPs in 11 Years

Hedge Fund Alpha is Negative; Down Around 1700 BPs in 11 Years

July 11, 2013

By Jacob Wolinsky

hedge-fund-alpha-1024x443 hedge-fund-correlation

Adam Parker of Morgan Stanley is out with a new report on the S&P 500. He notes that hedge fund alpha has tanked since early 200s and today is still negative, with a drop of about 1700 basis points. At the same time correlation is up making many hedge funds appear to be nothing more than closet index funds.

Adam S. Parker, Ph.D., Chief US Equity Strategist, Morgan Stanley, is out with a great new report titled ‘US Equity Strategy’. In the 99 page report Parker has nearly a hundred interesting charts. Morgan Stanley sees the S&P 500 (.INX) in 2014 at 1600 in the base case scenario . However, the most interesting data is on hedge fund alpha and hedge fund correlation with the S&P 500 (.INX). HFRI and S&P 500 Correlation

In terms of correlation, the S&P 500 correlation with the HFRI Equity Hedge Index is moving up. Basically,investors are paying 2/20 to buy a closet index fund. As Parker puts it (in a much more eloquent fashion) ‘Hedge Funds in Aggregate Are Essentially Long the S&P 500′. See the chart below.

Although there is no explanation given, the rise in correlation is likely due to the macro dominated news atmosphere. Many investors have complained that stocks are not moving based on fundamentals, but rather based on what Ben Bernanke said (or didn’t say). With the stock market riding the QE gravy train most stocks are moving in tandem with the S&P 500 and broader market. This makes it an especially tough environment for value investors who have lamented in the past few years that investors have been ignoring fundamentals.

The other piece of data has to do with hedge fund alpha. The chart below speaks for itself and is another sad tale. Hedge fund alpha is now negative, meaning (for the large percentage who find alpha to be a useful metric) that hedge funds are underperforming.

When you put the two facts together you see how truly sad the situation is. Not only are many hedge funds just closet index funds with enormous fees, but investors are paying for both the underperformance (and risk adjusted underperformance).

Hedge Fund Alpha Abysmal

The final nail in the coffin, hedge fund alpha ( see chart at the top). Alpha was very high in the 1990s and up to about 2002 (it appears to have hit about 16 percent). Since then alpha has gone downhill and is now in the negative territory for quite some time (it appears to be negative one currently). While Parker notes that it is difficult for hedge funds to outperform in big up years alpha was high in the late 1990s. Furthermore, even though long biased hedge funds are having a better year than short biased funds, the numbers are still abysmal.

I would guess that alpha has fallen 1. Because there are so many more hedge funds with guys living in their parents basements charging 2/20 who might not be great money managers 2. Increasing correlation due to the large role central banks are playing in today’s market. Whatever the reason, it is hard to argue that investors would have been far better off putting their money in a hedge fund the past few years, as opposed to an S&P 500 index.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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