The fee structure and the relative underperformance obviously makes pension funds withdraw the money from HF. The biggest among the US pension funds, Calpers, announced to take 4 bn USD out of the HF investments.
Bromion - hate to derail this thread (not really) who are the funds that have done 25% CAGR > 10 years? I need to add 13Fs to my reading list.
Re the commodification of quant funds. I agree that quant strategies are increasingly commoditized, but that doesn’t mean that they don’t have market impact. It just means that if you’re a quant, it’s harder and harder to justify your job, because computers can do much of the same thing for you at a lower cost. Because the costs are lower, the computers are still out there doing their thing, and just get leveraged up or down depending on what the management (perhaps including the few quants remaining) thinks about their cost, risk, and profitability.
What that means is that if a bunch of the thousands of commoditized quant strategies have identified your short as something that should be shorted (perhaps because of trend following or some other feature that has started to become detectable because your short thesis is starting to work out), then they will glom onto it. In the beginning, this will help your position, because the loading up of quant strategies will tend to push the price down, but in a crash, it will still screw you. One key would seem to be the magic word “enough,” meaning that you have a price target of some sort, and close your position based on that, rather than reach for every last basis point of profit, which by definition requires the most expensive and hardest-to-hit tick (technically, it’s the least expensive, in a shorting situation, but ‘expensive’ has the right connotations associated with it).
As for compensation. One of the justifications for higher fees is if the HF strategy has size constraints (i.e. stops working if the AUM grows too large). The idea is that if size is a constraint, then a HF can’t simply grow AUM and charge a fee on assets the way a mutual fund does, so to attract a competent HF manager who keeps the fund profitable but not growing too fast, you need a higher payout rate as a percentage of assets.
I’ll just leave this here: http://web.mit.edu/alo/www/Papers/august07.pdf
I remember this week, the second week in 08/2007. P/CF was pretty much a perfect negative alpha factor, everything was inverted.
Yep, I remembre (uk spelling) that too.
Market neutral didn’t work, because every fund was reversing all positions in order to lever down. Common longs went down, common shorts went up. In addition, the betas changed dramatically so that portfolios that were expected to be market neutral ended up with high systemic exposure.
The lesson, market neutral won’t save you in a market crunch, particularly if there are margin calls and/or borrowing cost spikes. Market neutral creates nice uncorrelated returns in normal functioning markets (and that’s genuinely valuable), but it won’t save you in a crunch, because the tails are still highly correlated.
I don’t want to post that but if you want to send me a PM I will give you one name. There’s more than one but I don’t want to give the whole list.
Just wanted to update quickly:
I mainly agree with bchad on most of his points. I particularly agree on size constraints. I have a strategy that caps out at $200-300 million. There are investors who will gladly pay full fees to get into this vehicle since there are very few products like this on the market. I met one this week and they said we don’t even need to discuss fees, they will pay up and agree to a 3 year lock with a high water mark, subject to me passing a background check.
Also, I am not sure about how correlated the shorts are for market neutral. It depends on the level of short interest. Crowded shorts can behave very poorly regardless of market conditions. That’s one specific reason I won’t get involved with anything that has a high rebate – if you have to pay 30% to short something, time is not on your side. I prefer to maintain the ability to wait it out and not lose money. If the rebate is over 10%, it’s hard for me to get involved.