IU: Do you think that hedge funds as a group deliver alpha?

Kang: I'd say that, in general, the answer is no, and if I had to give a one-word answer, it would probably be "no," but that is because your question asks about hedge funds "as a group." Despite this, I don't that is an absolute argument not to get into hedge funds. For those investors who don't have the adequate resources, I would probably say it's not wise for you to get into hedge funds, since it's not like picking ETFs or a mutual fund manager. For those with the appropriate resources, hedge funds are a worthy addition to an asset-class-based or beta-focused portfolio.

The problem is, taking a look at hedge fund indices, in general, during bull markets they track pretty closely to the index. During big down markets like 2000-2002, the performance is flat to slightly up, and thus it looks like a put option strategy was overlaid on there. So they do their job in major bear markets, but in general, like during the big climb from 2002-2007, during all those little blips, whether it was a subway bombing in London or even this past summer with mortgages, the hedge funds were going down in sync with the market.

I believe that the trick is to not invest too broadly into the hedge fund space, but really look for a set of unique and possibly small managers who have the ability to operate in certain capital markets that are very inefficient, like carbon trading or certain corners of the frontier markets or something of that nature. If you're looking at a hedge fund that's like a long-short U.S. equity fund, you'd have to wonder, with all the other CFAs, MBA, and Ph.D.s who are digging into the U.S. equity market, is it really possible to find that much inefficiency in it? It could be too difficult an environment to obtain alpha and justify the two-plus-20 fees. Or perhaps that's the point ... it is difficult to consistently find alpha in efficient markets, and that's why the fees are relatively high.

Anyway, when you start thinking about the fact that these smaller, more nimble managers have all kinds of risks because they're often less sustainable, being in an early stage of operation, it makes you wonder if these companies are more susceptible to failure. That's just the way business is in any industry. But those funds from large, well-established firms, like Goldman Sachs, that have successful track records, are closed to new investors. So either way, you're stuck. Interestingly, even for those large operations (whether they be open or closed to new investors), there's no guarantee of success as shown from Goldman Sach's Global Alpha program last year. Again, I'm not trying to be negative; I'm just saying it's a tough space and getting more competitive. A few investors, like Yale University, are successful at finding the right managers, but it requires a lot of unique resources.

IU: You talk about alternative energy on your site. Is it a sector that people should be looking at?

Kang: Yes, definitely. It's not a fad, obviously. There's real and justifiable concerns about what's happening to the planet.

The fact that there is a limited amount of oil out there is a concern. If you look at the Mideast countries, the oil producers, they're diversifying away from oil-many have recently invested in Wall Street investment banks. They're diversifying.

Some people call this commodity bull market a once-in-a-lifetime opportunity, and that's fine. But you have to think about the different scenarios-if oil goes up to $125, $150, or it goes down back to $50. If oil keeps going up, which it should, I believe, then there will be some reduction in demand, and consumers will try to wean themselves off of oil and get into alternative energy. But if the price of oil goes up, at the same time, alternative energy should also go up because its value increases as people realize that this is going to save their butt at the end of the day. And oil can't go up forever: At some point people are going to say, "Well I give up, that's it. I can't pay for that." And demand for oil is gone because it's just too expensive, driving prices down.

In that scenario, I think that alternative energy should keep going up because enough consumers have bought into it and enough people are putting solar panels on their roof and doing that kind of thing. To me, alternative energy is a participation in the ongoing energy bull market, but it should also be a hedge when oil goes down.

IU: Finally, is there anything that you think investors should take away from 2007?

Kang: Bull markets don't last forever. Risk is something that you didn't expect. You didn't expect that your money market holdings were going to do what it did-probably because someone called it a "risk-free asset." You can measure risk, but risk measurement and risk management are two totally different things. And perhaps the more that you measure your risk, the more you might actually have a false sense of security-and that in itself is one of the real risks that you have to manage. If you get that right, then you might actually might not just survive, but do well in the sideways or downwards market that we're in right now.

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