Wednesday, April 18, 2007

Selling beta for the price of alpha

The All About Alpha blog has posted a link to a recent EDHEC interview with "Handbook of Hedge Funds" author François-Serge Lhabitant, who talks a bit about hedge funds and their strategies.

Lhabitant also discusses replicable hedge fund strategies, and in the midst of some rather arcane discussion about possible replication of hedge fund performance, notes that some hedge funds may be "selling beta for the price of alpha".

Here's the quote in context:

In the average hedge fund, there are probably a lot of these static risk exposures and replication will work well. But in the “best” hedge funds - the few ones I am typically looking for as an investor - what I pay for is proprietary strategies with skilled traders, robust risk management and technology, and constant capital reallocation towards the best opportunities.

I am also buying the experience of a manager that has been going through crashes and knows what to do when liquidity dries out, his credit lines are pulled down and his level of margins revisited. This dynamic behaviour is very difficult to replicate and this is why I might agree to pay 2 and 20 and sometimes even much more.

So, my view is that if a fund is replicable ex-ante month after month by a simple “automated” strategy, then I am not interested in this fund – its manager is essentially selling beta at the price of alpha. Note that this is probably the case of the majority of hedge funds and hedge fund indices today, so why not replicate them…

He goes on to differentiate between these "automated" strategies and the replication approach suggested by Harry Kat via his Fund Creator vehicle, both the subjects of an earlier post.

Those EDHEC interviews seem like a cool resource for understanding more about the hedge fund world; I just feel like I need someone to explain them to me. Thanks to Abnormal Returns for pointing us to the link.