Category: Uncategorized

Hedge funds styles, strategies, and firms evolve over time. The behavior of a hedge fund today is not the same as yesterday. These behavior changes are not because a manager has changed his style but because the environment, the tools, the regulations, and the ideas surrounding finance are different. 

Alpha generation will fall when it is measured correctly through an appropriate benchmark. Alpha shrinkage over the last ten years is a measurement problem. Returns for hedge funds are a combination of the underlying risk premia styles employed and the skill of the manager. 

A growing investment management theme over the last few years has been the incredible shrinking alpha. As investors gain more information on risk premia, there seems to be less alpha produced by managers. In reality, alpha production has likely not changed, but our measure of alpha has gotten more sophisticated so the skill associated with any manager seems to have declined or at least changed over the last decade. We can now tie what was previously thought of as alpha to specific risk factors. If alpha is tied to systematic risk factors, then it really is not alpha.

Trend-following and momentum has always been an important part of hedge funds and alternative investing but it would be hard to say that trend-following was mainstream thinking prior to the early 90’s. This was the high water period of the market efficiency, but that thinking started to take a major change with the “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency”, published in the leading Journal of Finance. There were other papers that discussed similar topics and the behavioral finance paradigm shift had already begun, but this was the one paper that many academics started to quote with increasing frequency about momentum effects.

The channels of monetary policy are more important for any investigation of the macro economy. This is one of the key lessons from the Financial Crisis.  Now that short-term rates are finally moving higher, the behavior of banks with respect to their lending activities becomes more critical. It is expected that as rates move higher, the demand for loans will be lower. Additionally, there may be a tightening of lending when rates move higher. 

Emerging markets were talked about in many 2018 forecasts as the place to increase allocations both for bonds and stocks, yet that recommendation has been a performance disaster for many investors.  For both the last year and for longer investment periods, EM has not matched the performance of DM equities or bonds. The current causes are many: trade wars scares, low commodity prices, a strong dollar and currency crises, over leverage, slower recent growth, and some strong geopolitical blow-ups. There are strong risks present, yet the arc of economic progress and convergence is still in place for those who think in the long run.

“My mom always told me it’s okay to make mistakes, but she never worked at a hedge fund.”

― Turney Duff, The Buy Side: A Wall Street Trader’s Tale of Spectacular Excess

Decision-making will be filled with mistakes and failure. It is part of the process when making bets in an uncertain environment. No one is 100% certain and at your best, your track record will match your estimates for success. The objective of good investment decision-making is to get the process right, so failure or lack of success is not from lack of skill or outright ignorance. Nevertheless, even if the odds are in your favor, you will not get every decision right.