Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Monday, December 04, 2006

Department of "Huh?"

I must be slow and stupid. I don't understand in what sense this is a "hedge fund replication tool": / Home UK / UK - Goldman sets up hedge fund clone: By Steve Johnson: Goldman Sachs has become the first bank to create a hedge fund replication tool in a move that could lead to a shake-up of the $1,300bn hedge fund industry. The platform will greatly undercut the notoriously high fees of the hedge fund sector. Those investing through a fund of funds can end up paying annual charges of 4-7 per cent, with up to 50 per cent of their returns eaten up by fees. Goldman will charge a flat 1 per cent.

Goldman's Absolute Return Tracker index (Art), is set to be among the first of a flood of hedge fund cloning products likely to be launched in a revolution being compared with the arrival of index trackers in the mutual fund world a generation ago. "There is a lot of dead wood in the industry -- people who should not be running hedge funds," said Harry Kat, professor of risk management at London's Cass Business School, who has just launched his own hedge fund replication tool. "A lot of them will leave the business, because people are smartening up. Index replication is going to become as important as it is in traditional long-only investment, with 30-40 per cent of the market."

Replication strategies are based on academic research that suggests hedge fund performance is largely driven by movements in underlying markets, such as equity, bond and commodity prices, rather than the intrinsic skill of managers. Goldman has spent two years developing the algorithm that underpins its platform. The performance characteristics of thousands of hedge funds will be fed into the system monthly and Art is designed to decompose these data and calculate the aggregate position of the hedge fund universe. This position can then be replicated, potentially allowing Goldman to generate hedge fund performance at a fraction of the cost.

Clones such as Art avoid the negative selection bias that bedevils existing investible hedge fund indices and funds of funds, due to the fact that few of the better hedge funds are open to new investment. It will be far more liquid, with trading available on a daily basis. "This may be ideal for any large institution that has been looking at hedge funds but doesn't like the fact that it takes six months to put money [in] and to take it out again," said Edgar Senior, executive director in Goldman's fund derivatives structuring team.

Ummm... I was always taught that a hedge fund was something that tried to have a zero beta--hence "hedged"--and that tried hard to buy things that were undervalued and sell things with approximately the same risk characteristics that were overvalued, and hence produce greater-than-bond returns with bond-level risks.

I don't see why any good reason why some varying linear combination of stock, bond, and commodity returns would be worth a 1% per year fee. Of course, I don't see any good reason why the average hedge fund out there would be worth paying 2-and-20% to its managers. And I don't see why anybody back in 1929 held any shares of the Goldman Sachs Trading Corporation, which held a controlling interest in the leveraged Shenandoah Corporation, which held a controlling interest in the leveraged Blue Ridge Corporation, which held--get this--closed-end mutual funds that kept their investments private.

To celebrate, let's buy some stock certificates for the Blue Ridge Corporation (q.v. J.K. Galbraith, The Great Crash)


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