Need to write a paper about Issues the Hedge Fund Industry faces in 2008. Any ideas?
lack of qualified talent attempting to enter the field.
Someone told me that “decrease in alpha” is a current issue. Can someone explain?
Hedge funds need alpha males to run them. These days there aren’t as many.
Beer - decrease in alpha is a current and will be an ongoing issue because many hedgefunds are forced to deleverage. That is, if a hedgefund was levered 30 to 1, now that hedgefund is levered 20 to 1 or 10 to 1. A signficant amount of alpha is made off of the ability to leverage. So the question is - why is HF leverage coming down? 1) Haircuts (margins that brokers charge to borrow cash against collateral) are going up because a) broker balance sheets are decreasing (that is they don’t have as much cash to lend because other parties are hesitant or afraid to lend them x amount of money b) the world is getting more risky (ie. so now if you want to use your CMBS issue as collateral for borrowed cash, we are now charging you 10% margin instead of 2%) 2) Redemptions 3) Liquidity is drying up a lot in many markets (specifically segments of the fixed income market) which makes attractive trades impossible to execute or get the size desired. 4) As the result of the world getting more risky, many VaR models are getting tripped up, that is, models are now telling managers that they are way over their risk limits as a result of the current volatility that exists in the markets. Take your risk (ie leverage) down please.
Thanks cfa_gremlin!!! How about the following issue: “contagion among themselves and between the market”
“How about: “contagion among themselves and between the market”” I think this statement is trying to get at the fact that many HFs are in the same trade. If for example, a large HF gets a redemption or needs to take his leverage down, it’s going to try to liquidate the most liquid trades it has. If the HF is big enough, and the market smells liquidation going on somewhere, the market will jump on board, including the other HFs that have the same trade on fearing that the trade could go against them a considerable amount. Last one out the door is obviously a LOSER. So the “contagion effect” would be that many of the HFs have the same BIG trade on so the volatility AND direction of the trade is more technical (due to flows) rather than fundamental and the contagion can spread quickly.
What do you think about the “complex valuation” of certain Hedge Funds. Is this also an big issue today or was this always an issue?
complex valuation? - u got to be more specific - try google. i need rest. And - please include “CFA Gremlin 2008” in your footnotes. Plagiarism is a serious offense.
Complex valuation? Is that where value is divided into a real and an imaginary component?
Alpha is independent of leverage. Leverage doesn’t create alpha, it simply modifies a low risk/return trade into a high risk/return trade. I would be a big seller of the idea that the decreased availability of leverage for hedge funds will have a meaningful effect on industry returns.
do a paper on the rise of distressed debt H funds. seriously, meng. it is a new and relavant topic. some “alpha decrease” paper has been done 100 times before you and a decrease in alpha is obvious. the markets blew up and now we are seeing that deep on the tails, the HF infrastructure isnt as uncorrelated with the bogies. for real, dun. most MF and HF mgmrs are just indexing and increasing beta, then capturing a 2/20 to fund the purchase of home # 4 in Avon, CT. what a ripoff.
I think Alpha and leverage are related somehow. In FI arbitrage, you often need to lever to turn a few basis points of alpha into a percent or two. If leverage becomes more expensive, it is harder to do that. So, in theory, alpha must exist independently of leverage, but in a real fund, how much alpha you claim you can deliver can be related to the amount of leverage you’d be able to take on. – I agree that it’s probably easier to contribute to knowledge on distressed debt funds than on whether alpha is drying up. – Bob Litterman’s been plugging his “exotic beta” as a middle ground between market beta and alpha. As far as I can tell, it’s mostly about beta from non-market factors that shows some kind of persistence over time. The theory is that over the very long term, only market beta should matter, but that there are cycles where other beta factors perform, and these cycles show their own kind of permanence or momentum that is potentially useful in developing return models. – As for marketing beta as if it is alpha; remember that one source of alpha is security selection, and another source of alpha is beta timing. If what is happening is that a HF is just levering up beta and packaging it as alpha, then you shouldn’t be paying, but if there is genuine beta timing skill (suggesting that the beta leverage changes over time, and correctly), that is worth paying for. A lot of people don’t believe that beta timing can be done, and therefore paying 2/20 for any kind of beta is just not defensible. However, I think that even security selection could be seen as a kind of market-timing activity on the micro scale (is now the time to go long or short this stock), so if one believes in security selection alpha, then it is at least in principle possible to do beta timing that is worthy of being compensated.
risk control. how do you measure risk now that var and mark-to-market concepts are found to be less than optimal
beer2000 Wrote: ------------------------------------------------------- > What do you think about the “complex valuation” of > certain Hedge Funds. Is this also an big issue > today or was this always an issue? I like bchadwick’s quip on complex as complex covers lots of sin. Hedge funds buy lots of illiquid stuff, but there is lots of pressure for hedge funds themselves to be liquid (mutual funds can have the same problem). Beyond that, most hedge funds report NAV or VAMI or whatever they call it much more frequently than the investments can be valued. At hedge funds I’ve worked at good clients have insisted on pro-forma performance estimates faxed by 5:00 PM and call up and gripe if they turn out to be wrong. But to turn to one of my favorite investments - a hedge fund buys a claim on a defaulted lease in a Venezualan bankruptcy court. The claim is denominated in Bolivars, will be resolved at some uncertain time in the future, paid out at some uncertain time after that, paid some uncertain amount, and subject to all manner of Chavez risk. Now by 5:00 PM someone has to revalue the thing and put it on a fax. In truth, nobody cares about the fax because that better not be a huge percentage of the portfolio, but when people buy and redeem they are buying and redeeming at prices you have assigned to that investment. In reality, the trader says that he expects to make 23% annually on the investment and someone’s spreadsheet marks it up each day as if it was a risk-free 23% investment. If the investment becomes significantly impaired, the trader probably marks down the price on whatever day he decides to do such things and the spreadsheet starts ticking up again. Things like this are what give hedge funds negative skew and positive autocorrelation. The larger picture is that these investments are “marked to model” which might be a reasonable thing to do except the models might be wrong, the models are heavily influenced by the incentive fee structure of the fund, the models aim at expected valuation and do not include randomness so hedge fund NAV’s are less volatile than they ought to be, and for a whole bunch of reasons subject investors to “big bath” problems as the fund sticks by models that are favorable but wrong until they finally can’t. Last guy out the door gets left holding the bag. An interesting aspect of this is that you would think that someone would object to the risk-free 23% investment but the industry has no controls for this. Typically, the trader writes a valuation memo which is given to the compliance officer and accounting (neither of whom are likely to know anything about valuation). The memo goes to the fund acocuntants who are external but will accept anything on the memo. The auditors who then check the numbers check for compliance with the valuation memo (they also don’t know anything about valuation) but are otherwise not interested in the model. The risk manager may care but has no good solution.