Alpha - September 2007 - (Page 34)

“The world as we knew it is not going to come back,” says Ivy Asset Management global head of investments Stuart Davies (left); longtime risk manager Richard Bookstaber says sickly subprime mortgages infected healthy debt instruments. of environment in which asset allocators look to hedge funds to protect their portfolios, but there seems to be a lot less ‘hedge’ in hedge funds than there used to be.” Some experienced investors fear that there is also a lot less alpha in hedge funds, arguing that record asset inflows and greater competition have eroded investment opportunities. Mark Anson, president of Chicago-based Nuveen Investments, says the vast majority of hedge fund managers have simply been delivering beta disguised as alpha over the past couple of years — and charging huge fees to their investors for the privilege of buying market exposure. “Pure alpha, as we once knew it, is becoming increasingly scarce,” explains Anson, who as chief investment ofﬁcer of the California Public Employees’ Retirement System was one of the ﬁrst public pension executives to advocate investing in hedge funds. “When you have $1.7 trillion invested in hedge funds globally, and all of those market participants coming in and chasing alpha, you begin to develop systemic risk factors that look a lot more like beta than they do like alpha.” August’s broadly disappointing returns force investors to make a difficult choice: stay the course, putting their faith in their managers to recover, or pull back, redeem and reallocate. Investors are starting to ask whether hedge funds are truly worth the cost — both in terms of the high fees they charge and the effort it takes to analyze and monitor their strategies. Although a shakeout is almost inevitable — some managers will be put out of business — the recent turbulence also gives investors the opportunity to identify hedge funds that are truly providing alpha. “The world as we knew it is not going to come back 34 • INSTITUTIONAL INVESTOR’S ALPHA • SEPTEMBER 2007 and offer us the same opportunities,” says Stuart Davies, global head of investments at Ivy Asset Management Corp., a Jericho, New York–based firm that manages $15 billion in funds of hedge funds. “We’re in a readjustment phase now — and this will be a phase in which illiquidity is significant, and relationships [between markets and instruments] can be distorted, so you need to make sure that the managers you’re working with are managing risk and thinking ahead.” Unlike previous market dislocations in recent memory — such as the credit shock in the spring of 2005, when rating agencies downgraded the debt of the big U.S. automakers to junk bond status — this one could have staying power. Early this month an unexpectedly grim report from the U.S. Department of Labor showed an abrupt drop in employment in August; the economy shed 4,000 jobs, raising fears of a recession. Stocks plunged on the news, and the Standard & Poor’s 500 stock index closed down 1.69 percent on Friday, September 7. A week later Secretary of the Treasury Henry Paulson Jr. downplayed the significance of the employment figures, saying in an interview with CNBC that he felt conﬁdent that the economy would continue to grow, despite the tumult in the financial markets, because unemployment is still low, real wages are rising, and inflation has been contained to date. “That is obviously the key to extending economic expansion,” he said. The Fed, which slashed the benchmark federal funds overnight lending rate 50 basis points to 4.75 percent on September 18, will have to walk a ﬁne line between managing the risk of inﬂation and easing illiquidity in the ﬁnancial markets. That interest rate headache is now Bernanke’s to endure, but former Fed chairman Alan Left photo by TomTavee; right photo by Greg Miller for Alpha

Table of Contents Feed for the Digital Edition of Alpha - September 2007

Contents Letter from the Editor Longs & Shorts Pension Corner: Keeping the Faith The Good Guys: Going Public Interview: Barry Bausano - A Delicate Balance Cover Story: Cruel, Cruel Summer Profile: Phil Cooper - Alternative Flight Plan Strategies: Marshall Wace - TOPS in Its Field Profile: Fortis Investments - Banking on Alternatives Research Center: Top Equity Trading Firms Alpha Bytes: Desktop Duel Unhedged: Commentary - The Taxman Cometh

Alpha - September 2007

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