Tuesday, June 5, 2018

Cliff Asness: "The Hedgie in Winter"

From AQR's Cliff's Perspective, May 31, 2018:
Cliff Asness
Once again, I will review why hedge fund returns shouldn’t be compared to 100% long equities and how to do a more proper comparison. Analysts and authors often compare hedge fund returns to 100% equities (most often, the S&P 500). Then, almost always based on the last nine years since the global financial crisis (GFC) lows, they declare hedge funds an epic disaster. That’s just flat-out wrong. Comparing hedge funds to 100% equities would be a bad comparison at any time. To make things worse, this comparison is done over a cherry-picked time period. So this one has it all! An always fallacious comparison conducted over a particularly extreme period for that always fallacious comparison.

While I’m harshly critical of the above ubiquitous, but broken, comparison, I certainly don’t rescue hedge fund performance since the GFC. Not close. Actually, I show that doing the comparison correctly, hedge funds have petered out in the last third to half of my sample, adding little to no value. “Petering out” means not adding or subtracting much value. This is far less extreme than the commonly reported epic disaster of hedge funds destroying many billions of dollars of their clients’ money, which follows from the aforementioned fallacious comparison. But it’s still not very good. I go on to endeavor to figure out why, if not just a random occurrence which is always possible, this “petering” has occurred.

I compare hedge fund returns with the returns from traditional long-only stock-picking. I argue that much of the “petering out” of hedge funds in the last third of our sample is likely due to hedge funds transforming from something mostly different from traditional stock picking (from say the early 1990s to the early 2000s – and likely even more true earlier in time, but unfortunately we don’t have reliable data much earlier) to something far closer to traditional active mutual funds (early 2000s to now) … but with higher fees. 1
Much of the “right” way to critique hedge funds I study here is ground I’ve covered before. That is, we must compare hedge funds to the right beta (not 1.0) and, perhaps, adjust for other well-known factor exposures. But part is new, critiquing hedge funds not simply for providing far less alpha in more recent times, but, partially and provisionally, explaining why. It’s not just their returns that have gotten more pedestrian, but the actual strategies they employ have as well. This is different from, and more concerning than, say, still relatively unique strategies just having a poor period (which, of course, can happen).

The Wrong and Right Way
Legions of journalists, pundits, bloggers, FinTwits, famous investors, and other financial glitterati, have made very critical comments about hedge fund performance — most, if not all, is based on incorrect analysis.

I have tilted at the windmill of this silliness before (two examples are here and here). 2 But, apparently, shockingly, I have not had great influence on the dialogue as the bad comparisons and histrionic statements that follow them still dominate the discourse. So, once more I raise my lance, spur on my faithful destrier, and charge, dreaming the impossible dream that this time I’ll be more convincing. If a picture helps, try this one (I’m the squinting dude):...MUCH MORE
Previously from Cliff's Perspective:
Clifff Asness, AQR—"Risk Parity Derangement Syndrome"
A Mini-Mea Culpa: Cliff Asness and Risk Parity
AQR Capital's Cliff Asness on Environmental/Social/Governance (ESG) Investing
The footnotes are pretty interesting and a possible threat to Matt Levine's hitherto unchallenged fn dominance...
AQR's Cliff Asness on CalPERS Hedge Fund Decision