WHEN ALPHA REALLY ISN’T BETA
There is a limit to how far alternative beta can go, however.
The significant dispersion between hedge fund managers’ returns underlines the wide variety of construction methodologies used to access each form of alternative risk premia across the universe.
“Every hedge fund has an element of beta and, hopefully, also an element of alpha,” says Aon’s Towsey. “It can be very difficult to disentangle the two.”
Alternative beta will never completely replace hedge funds, which still have a lot to bring to the table in terms of their ability to provide diversification, and return benefits, particularly in illiquid areas where alternative beta products cannot really compete. Their tool set to take advantage of market opportunities is also wider and, in some cases, it is questionable whether some factors that underpin enhanced beta strategies are really beta at all.
“Some factors may not have true economic reasons behind their past performance,” warns Lisa Fridman, managing director at Pacific Alternative Asset Management Company (PAAMCO).
A HELPING HAND
And genuinely good hedge fund managers should not feel threatened by alternative beta. Quite the opposite – it should help them better demonstrate how much alpha they are actually able to deliver.
Most hedge funds will compare their performance to an index, such as those included in the HFRI series. Alternative beta indices allow for a more targeted comparison in some areas and managers who outperform may find their audience more compelled to listen.
As Aon’s Towsey says: “Investors don’t have a problem paying hedge fund fees if they are getting alpha.”
Clearly not all alpha can be translated into beta and alternative beta will co-exist alongside hedge funds. Although they bring challenges that hedge funds must overcome (to the benefit of investors), they work in favour of hedge funds that are able to offer genuine idiosyncratic returns. What alternative beta strategies have done is afforded investors a better understanding of the different elements of return. That has paved the way to significant cost savings, as has already been shown in the case of CTAs.
Bryon Lake, head of Invesco PowerShares – EMEA, argues: “Investors can now choose the strategies that they want and have more options to achieve the market outcomes they are seeking. If they find that portions of their portfolios can be delivered in a cost effective package, they may begin to shift towards smart beta. On the other hand, as they see hedge funds that are actually providing alpha above and beyond smart beta strategies, they will see that they may be worth paying a premium for these skilled managers.”
