Larry Swedroe: Public Vs. Private Hedge Funds

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Random Walker
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Larry Swedroe: Public Vs. Private Hedge Funds

Post by Random Walker » Wed May 15, 2019 9:35 am

https://www.etf.com/sections/index-inve ... nopaging=1

As Larry has written before, hedge funds have had a miserable decade. Here he reviews a study of hedge funds that have gone public. The study looks at Pre IPO performance vs. Post IPO performance. Post IPO performance lags significantly. It looks like the reason is that self interested managers are more interested in increasing AUM than fund performance.

Dave

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by nedsaid » Wed May 15, 2019 9:41 am

Pretty much, there is no reason for individual investors to invest in hedge funds. Larry should follow up with an article about AQR and how it is different from hedge funds. Hopefully, it really is different.
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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by garlandwhizzer » Wed May 15, 2019 1:01 pm

Random Walker wrote:

It looks like the reason is that self interested managers are more interested in increasing AUM than fund performance.
More interested in increasing their own incomes rather than shareholder profits? Astounding!

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by BJJ_GUY » Thu May 16, 2019 2:22 am

nedsaid wrote:
Wed May 15, 2019 9:41 am
Pretty much, there is no reason for individual investors to invest in hedge funds. Larry should follow up with an article about AQR and how it is different from hedge funds. Hopefully, it really is different.
Just like other big quant shops, AQR has many different hedge funds. They also have a bunch of other investment vehicles following long-only strategies. Since the term 'hedge fund' is used to represent a huge universe of very different funds/strategies as if they were homogenous... then I don't see how or why AQR would be different.

Does that answer the question, or is there a particular concern specific to AQR? I'd otherwise take anything written about the 'hedge fund market place' with a grain of sand.

What if Morningstar provided an average return for all mutual funds the cover? That is hundreds of money market funds, bond funds, equity funds etc. So what exactly would an average return explain? Now, it should be noted that the dispersion of returns between 'hedge fund strategies' is very wide - more so than mutual funds, not to mention funds within the same strategy labels tend to have really wide dispersion of returns too. In other words, the average Morningstar mutual fund return is more meaningful than what we are to understand based on the HFRX performance

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by bgf » Thu May 16, 2019 7:52 am

Random Walker wrote:
Wed May 15, 2019 9:35 am
It looks like the reason is that self interested managers are more interested in increasing AUM than fund performance.

Dave
lol, shocking news! individuals paid primarily based on assets under management focus more on increasing assets, which is the easy task, than the hard task (earning higher returns).
“TE OCCIDERE POSSUNT SED TE EDERE NON POSSUNT NEFAS EST"

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by nedsaid » Thu May 16, 2019 8:57 am

BJJ_GUY wrote:
Thu May 16, 2019 2:22 am
nedsaid wrote:
Wed May 15, 2019 9:41 am
Pretty much, there is no reason for individual investors to invest in hedge funds. Larry should follow up with an article about AQR and how it is different from hedge funds. Hopefully, it really is different.
Just like other big quant shops, AQR has many different hedge funds. They also have a bunch of other investment vehicles following long-only strategies. Since the term 'hedge fund' is used to represent a huge universe of very different funds/strategies as if they were homogenous... then I don't see how or why AQR would be different.

Does that answer the question, or is there a particular concern specific to AQR? I'd otherwise take anything written about the 'hedge fund market place' with a grain of sand.

What if Morningstar provided an average return for all mutual funds the cover? That is hundreds of money market funds, bond funds, equity funds etc. So what exactly would an average return explain? Now, it should be noted that the dispersion of returns between 'hedge fund strategies' is very wide - more so than mutual funds, not to mention funds within the same strategy labels tend to have really wide dispersion of returns too. In other words, the average Morningstar mutual fund return is more meaningful than what we are to understand based on the HFRX performance
My point was that Larry Swedroe has written pretty extensively about the poor performance of hedge funds as a group. He then endorses certain AQR Funds that employ similar strategies. Asking Larry to follow up on this question I ask seems pretty logical to me. Pretty much I am asking what is different about AQR and why should we invest with them and not the Hedge Funds themselves?

Yes, we know that there are different strategies employed by this class of funds. But it seems a cop out to just throw up our hands and say that since hedge funds are diverse in strategies and therefore we can't benchmark them. Some of these are aiming for equity like returns with low correlation to the stock market. So shouldn't funds making this claim be benchmarked against equity investments?

Morningstar uses a number of benchmarks for mutual funds. For one thing, stock funds and bond funds are benchmarked differently. For another thing sub-classes are benchmarked not only against the broad stock or bond index but also against category average. Morningstar really isn't publishing an average mutual fund return without regard to its asset class. Your point that a hedge fund index may not be "fair" is a good one, but the Hedge Fund Index is what we have. We could do the equivalent of a category average for hedge funds.

My point is that Hedge Funds should be benchmarked against their claims. In other words, do the funds do what the sponsors say they are going to do? If they promise equity-like returns, do they in fact deliver equity-like returns? If they promise low correlation to stocks, is low correlation actually delivered upon, particularly in a crisis?
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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by Random Walker » Thu May 16, 2019 9:40 am

Hi Nedsaid,
I think your question for Larry is a very reasonable one, and I’d look forward to that essay as well. I’m sure a major theme would be that AQR funds are passive. They are passive in the sense that they are formulaic with no market timing or specific security selection. They do perform some volatility scaling of their positions. Interestingly though, I think Asness has referred to the AQR funds as active.

With regard to benchmarks, I wouldn’t benchmark a long-short multi style multi asset class fund with equity like expected returns against a specific equity index. Instead I’d use the term “equity like expected returns” to look for returns perhaps 5-7% over T bills. I’d look at the absolute returns and the correlations to various asset classes. If I understood statistics better, I’d also say to look at covariances.

I once made the comment that DFA funds sort of serve as their own indexes. Didn’t go over very well around here, but it’s true. Once one appreciates that a fund gets what it’s factor exposure gets, then what really matters is that the fund is true to its mandated exposure to the factors, asset classes, and strategy. That’s why I think it’s fair to view an AQR fund that Asness might even call active as effectively passive.

Dave

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by BJJ_GUY » Thu May 16, 2019 10:36 am

nedsaid wrote:
Thu May 16, 2019 8:57 am
BJJ_GUY wrote:
Thu May 16, 2019 2:22 am
nedsaid wrote:
Wed May 15, 2019 9:41 am
Pretty much, there is no reason for individual investors to invest in hedge funds. Larry should follow up with an article about AQR and how it is different from hedge funds. Hopefully, it really is different.
Just like other big quant shops, AQR has many different hedge funds. They also have a bunch of other investment vehicles following long-only strategies. Since the term 'hedge fund' is used to represent a huge universe of very different funds/strategies as if they were homogenous... then I don't see how or why AQR would be different.

Does that answer the question, or is there a particular concern specific to AQR? I'd otherwise take anything written about the 'hedge fund market place' with a grain of sand.

What if Morningstar provided an average return for all mutual funds the cover? That is hundreds of money market funds, bond funds, equity funds etc. So what exactly would an average return explain? Now, it should be noted that the dispersion of returns between 'hedge fund strategies' is very wide - more so than mutual funds, not to mention funds within the same strategy labels tend to have really wide dispersion of returns too. In other words, the average Morningstar mutual fund return is more meaningful than what we are to understand based on the HFRX performance
My point was that Larry Swedroe has written pretty extensively about the poor performance of hedge funds as a group. He then endorses certain AQR Funds that employ similar strategies. Asking Larry to follow up on this question I ask seems pretty logical to me. Pretty much I am asking what is different about AQR and why should we invest with them and not the Hedge Funds themselves?

Yes, we know that there are different strategies employed by this class of funds. But it seems a cop out to just throw up our hands and say that since hedge funds are diverse in strategies and therefore we can't benchmark them. Some of these are aiming for equity like returns with low correlation to the stock market. So shouldn't funds making this claim be benchmarked against equity investments?

Morningstar uses a number of benchmarks for mutual funds. For one thing, stock funds and bond funds are benchmarked differently. For another thing sub-classes are benchmarked not only against the broad stock or bond index but also against category average. Morningstar really isn't publishing an average mutual fund return without regard to its asset class. Your point that a hedge fund index may not be "fair" is a good one, but the Hedge Fund Index is what we have. We could do the equivalent of a category average for hedge funds.

My point is that Hedge Funds should be benchmarked against their claims. In other words, do the funds do what the sponsors say they are going to do? If they promise equity-like returns, do they in fact deliver equity-like returns? If they promise low correlation to stocks, is low correlation actually delivered upon, particularly in a crisis?
I'm with you on all this. I didn't know if there was a specific question about AQR, that was all. They have probably more than 100 strategies, so I had no idea what you were referring to. (FYI... They would have been happy to trade the performance of most of their hedge funds for that of the crappy HFRX last year!)

Your point about Morningstar having strategy and even sub-strategy level benchmarks isn't all that different from hedge funds. Although, public market passive indexes are good benchmarks, whereas the hedge fund benchmarks are pretty shaky at every level. My comment about the average Morningstar return was really just to show how silly it is that most writers use that HFRX without hesitation. There aren't better options I guess, it just seems silly that it's used at all, I guess.

As an aside, I hear writers and others say what you did which is basically to the effect of "hedge funds should claim to beat equity, or get equity-like returns if they don't want that benchmark." I would fully agree with this statement. Problem is, outside of the long/short equity world that isn't the expectation being sold... Funny thing is, the HFRX would be a better benchmark for most hedge funds than the SPX. Which would mean that a significant number of funds have OUTPERFORMED the market last year and over most since 2008!

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by nedsaid » Thu May 16, 2019 12:31 pm

When I think of AQR, I think of QSPIX, AQR Style Premia Alternative Fund I. This fund has been discussed a lot here, indeed it has its own lengthy thread. This fund and a very similar tax aware fund have been recommended by Larry Swedroe and Buckingham. Yes, AQR does a lot of things including long only funds. But most all the discussion here has centered on their funds that use shorts and leverage.

QSPIX in my view has been a disappointment, its 5 year return is 2.39%. One could say it has low correlation to the US Stock Market but so does money stuffed in my mattress. Vanguard Total Bond Market Index Admiral has returned 2.46% over the same time period. Bonds did a bit better and with probably better diversification benefits. These type of alternative funds need to do better than plain, boring, old bonds.
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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by BJJ_GUY » Thu May 16, 2019 1:00 pm

When a firm is as big as AQR, decides to enter mutual funds to provide watered down versions of their private funds (like Style Premia Alternative you mentioned) then it's hard to conclude much about their priority of motivations. If I were an LP in their hedge fund and saw that behavior, I'm out the door. No reason to stick around to see how it plays out.

AQR got lucky when 2008 happened just as they were going to IPO. At least they dont have the inherent conflict of interests publics have where the interest of investors is at odds with shareholders. Also, public companies can't share as much information in a timely fashion with investors, which also boggles my mind why anyone would make that investment

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by nisiprius » Thu May 16, 2019 3:44 pm

nedsaid wrote:
Wed May 15, 2019 9:41 am
Pretty much, there is no reason for individual investors to invest in hedge funds. Larry should follow up with an article about AQR and how it is different from hedge funds. Hopefully, it really is different.
Mutual funds and ETFs are kinds of "investment companies," regulated by the Investment Company Act of 1940. So, yes, mutual funds, any mutual fund, even the most hedge-fund-like of AQR's or anyone else's mutual funds, are very different from mutual funds.

For a good summary see Comprehensive Regulatory Regime for U.S. Mutual Funds.

Three big differences are liquidity, limitations on leverage, and diversification. Another is transparency. All regulations are imperfect but nevertheless these are big differences that make mutual funds significantly less risky than hedge funds.

Mutual funds are required to provide daily liquidity--they must value their funds daily, and allow you to redeem fund shares at NAV at the end of the day. And the mutual fund must actually deliver the cash to you within, I can never remember exactly, I think it is seven calendar days. Because they are required to deliver daily liquidity, they are also required to put 85% of the fund into liquid assets. The result of this is that the fund's valuation is likely to be quite realistic because most funds are investing mostly in assets that have a real market and a real market value. I read one analysis that asserted that risk/reward statistics for hedge funds are inaccurate because there isn't a true valuation of the assets and they appear to have values more stable than they really are.

Mutual funds are limited to actual leverage--borrowing money--to no more than 33% of the fund's asset value. Funds can get some of the effect of leverage by investing in derivatives, but they can only use small amounts of borrowed money.

The diversification requirement is complicated and the only consequence of not doing it is that the fund must be declared as "not diversified."

Transparency means the fund must periodically report its holdings; you know what it is investing in.

This stuff isn't trivial and shouldn't be taken for granted.

Also, of course, the fee structure of most hedge funds is far heavier than that of even very expensive mutual funds.
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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by nedsaid » Thu May 16, 2019 5:01 pm

nisiprius wrote:
Thu May 16, 2019 3:44 pm
nedsaid wrote:
Wed May 15, 2019 9:41 am
Pretty much, there is no reason for individual investors to invest in hedge funds. Larry should follow up with an article about AQR and how it is different from hedge funds. Hopefully, it really is different.
Mutual funds and ETFs are kinds of "investment companies," regulated by the Investment Company Act of 1940. So, yes, mutual funds, any mutual fund, even the most hedge-fund-like of AQR's or anyone else's mutual funds, are very different from mutual funds.

For a good summary see Comprehensive Regulatory Regime for U.S. Mutual Funds.

Three big differences are liquidity, limitations on leverage, and diversification. Another is transparency. All regulations are imperfect but nevertheless these are big differences that make mutual funds significantly less risky than hedge funds.

Mutual funds are required to provide daily liquidity--they must value their funds daily, and allow you to redeem fund shares at NAV at the end of the day. And the mutual fund must actually deliver the cash to you within, I can never remember exactly, I think it is seven calendar days. Because they are required to deliver daily liquidity, they are also required to put 85% of the fund into liquid assets. The result of this is that the fund's valuation is likely to be quite realistic because most funds are investing mostly in assets that have a real market and a real market value. I read one analysis that asserted that risk/reward statistics for hedge funds are inaccurate because there isn't a true valuation of the assets and they appear to have values more stable than they really are.

Mutual funds are limited to actual leverage--borrowing money--to no more than 33% of the fund's asset value. Funds can get some of the effect of leverage by investing in derivatives, but they can only use small amounts of borrowed money.

The diversification requirement is complicated and the only consequence of not doing it is that the fund must be declared as "not diversified."

Transparency means the fund must periodically report its holdings; you know what it is investing in.

This stuff isn't trivial and shouldn't be taken for granted.

Also, of course, the fee structure of most hedge funds is far heavier than that of even very expensive mutual funds.
I should buy the very expensive mutual funds and avoid the very, very expensive hedge funds. :wink: So pretty much you are saying the AQR funds such as QSPIX in comparison to hedge funds charge less fees, have less leverage, offer more transparency, and offer daily liquidity.

Better questions for me to ask would be how does the performance of funds such as QSPIX compare to their hedge fund cousins? Also how much leverage is there in certain AQR funds compared to hedge funds? We know there is an illiquidy premium. How much performance does AQR sacrifice by providing daily liquidity?
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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by BJJ_GUY » Thu May 16, 2019 5:21 pm

nisiprius,

Many of those characteristics you listed as being favorable for mutual funds, as compared to hedge funds, have the potential to be value destructive.

Specifically, the idea that it's a positive that mutual funds must mass redeem even when invested in markets that are anything less than highly liquid. Bank loans, some thinly traded debt, reorganized equity, and other no exchange-traded investments will be unable to sell, or they will be forced to sell far below intrinsic value (and certainly below current marks).

I'm not saying you are wrong by any means. But I do think there are a lot of less responsible players operating mutual funds. The sad thing about this is that common investors take the 40 act regulations to mean the rules will be executed without a hitch. The false sense of security is not there with hedge funds, so investors tend to get a better understanding of what they're buying and the potential liquidity mismatch. Final thing that is a killer with mutual funds in outflow scenarios, is it really does become a bit of a race out the door as investors realize they should sell at the NAV that may not be obtainable tomorrow etc. Hedge fund illiquidity provides a more equitable means of outflows where no investor can exit at the disadvantage of others (pro-rata speaking).

All that said, I'm not here arguing for hedge funds. Only pointing out the potential risk where retail folks think the SEC has them covered

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Re: Larry Swedroe: Public Vs. Private Hedge Funds

Post by gtwhitegold » Mon May 20, 2019 7:13 am

BJJ_GUY wrote:
Thu May 16, 2019 5:21 pm
nisiprius,

Many of those characteristics you listed as being favorable for mutual funds, as compared to hedge funds, have the potential to be value destructive.

Specifically, the idea that it's a positive that mutual funds must mass redeem even when invested in markets that are anything less than highly liquid. Bank loans, some thinly traded debt, reorganized equity, and other no exchange-traded investments will be unable to sell, or they will be forced to sell far below intrinsic value (and certainly below current marks).

I'm not saying you are wrong by any means. But I do think there are a lot of less responsible players operating mutual funds. The sad thing about this is that common investors take the 40 act regulations to mean the rules will be executed without a hitch. The false sense of security is not there with hedge funds, so investors tend to get a better understanding of what they're buying and the potential liquidity mismatch. Final thing that is a killer with mutual funds in outflow scenarios, is it really does become a bit of a race out the door as investors realize they should sell at the NAV that may not be obtainable tomorrow etc. Hedge fund illiquidity provides a more equitable means of outflows where no investor can exit at the disadvantage of others (pro-rata speaking).

All that said, I'm not here arguing for hedge funds. Only pointing out the potential risk where retail folks think the SEC has them covered
For investment companies marketing to retail investors, they should do a certain amount of due diligence before making an investment publicly available. With the advent of interval funds, investment companies are able to provide strategies focused on less liquid areas of the investment marketplace.

I'm not sure if a mutual fund could be converted into an interval fund after creation, but it should be considered to avoid something like the Third Ave Junk Fund liquidation.

Edited to clean up wording.

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