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“And you thought ‘A Night At The Opera’ was funny?”
Kermit the Frog complained in song, “It’s Not Easy Being Green.” Well, nowadays, it’s not easy being a hedge fund. Oh, the hedgies are used to reproach alright, having weathered constant complaints about their “two-and-twenty” fee structure and their tendency to be more opaque than room air at the annual Tri-Delt poker tournament.
Recently, though, it’s grumbling about performance that’s rising above the usual din. Investors and the media—those selfless watchdogs of the public weal, or, those scurvy, clueless curs (you choose)—seem to have fixated on recent numbers showing hedge funds limping behind the domestic equity market. In the past five years, for instance, the HFRX Equal-Weighted Strategies Index produced a compound annual growth rate of 5.8 percent versus the 6.4 percent earned by the Dow Jones Wilshire 5000.
To quell the growing dyspepsia, hedge funds have begun investing heavily in education. No, Bridgewater Associates isn’t dropping coin on your kid’s middle school. Instead, funds are trying to get investors and the media to understand what a hedge fund really is. “Hey,” they say, “we’re for reducing risk—really.”
Unfortunately, convincing the hoi polloi is as daunting a task as convincing the French that Napoleon’s foray to Waterloo was just a shopping trip for Belgian lace. Not that the hedgies don’t have a point, mind you. They do. While aggregate fund performance has fallen short of the market, alternative strategy investors had their downside volatility markedly reduced. HFRX’s Sortino ratio over the past five years is six times that of the Wilshire benchmark.
Try explaining that as a “win” to a business reporter though. Stories about diversification benefit and kurtosis, they’ll tell you, just don’t curry the interest of readers up in Possum Lake. Even the scribes of mainline financial rags have trouble making a concept like skewness sexy.
No, educating the nonfinancials isn’t easy, Kermit. For most folk, hedge fund risk analysis makes as much sense as a Marx Brothers movie. Here, in fact, are common examples of what most people apprehend when risk factors are mentioned in a story:
What is written—Theta, the likelihood of extreme events leading to either windfalls or collapses. What is perceived—Harpo, the perpetrator of zany antics that moved thinly written scripts along.
What is written—Gamma, the skewness of a fund’s returns distribution. What is perceived—Zeppo, the sunniest Marx who thought, er, positively.
What is written—Alpha, the excess return earned through a manager’s skill. What is perceived—Groucho, the prime mover in the Marx universe.
What is written—Beta, the variability of an asset relative to a benchmark. What is perceived—Chico, who, playing against Harpo, seemed almost sedate.
With this in mind, the educational mandate for hedge funds is clear: illustrate the ability to deliver high gamma and low theta. In other words, show a lot of Zeppo, but little Harpo.
Disclaimer: The Journal of Indexes editorial staff wishes to state that the views expressed in this column are solely those of the author, a clearly demented soul with few redeeming qualities other than a deadly fastball and a decent wine cellar.
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