The case for hedge fund betas: lessons learned about correlations

US-based quant shop AQR Capital has helped pioneer the notion of hedge fund beta as an investable product. With first-year performance numbers now in, GREG BRIGHT spoke with the firm’s managing and founding principal, Cliff Asness. Cliff Asness has been talking about hedge fund beta for some years. He wrote a paper about it, with others, in 2001 in which he had the audacity to suggest that most hedge funds were more correlated with the markets than they had let on, or thought. The paper made him rather unpopular, he says, with his hedge fund colleagues.

Nevertheless, the founding and managing partner of Connecticut-based quant manager AQR Capital Management persevered with this notion and as an evolution of that early insight, Asness now points out that even after accounting for the market exposure, hedge fund returns are not all alpha. Much of the industry’s returns can be better classified as hedge fund beta. Hedge fund betas are common risk factors shared by hedge fund managers (or other active investors) pursuing similar strategies. Many of these hedge fund betas can be captured through a bottom up, systematic implementation of the strategies and at the same time, hedge fund betas have an economic intuition that explains their returns. Asness is quick to point out that while investors should not pay as much for hedge fund beta as they pay for hedge funds in general, as there is no “magic” here, this still represented a sustainable and viable investment strategy to exploit.

AQR launched a product off the back of this work last year – the DELTA strategy – which is designed to provide investors with efficient, diversified, low cost exposure to a collection of underlying hedge fund betas with low leverage, improved liquidity and high transparency. The most aggressive version of the DELTA returned 26 per cent in the 12 months to September 30 after fees with a realised volatility of 5 per cent and a lower-octane version, which is what is now being marketed in Australia through an ASIC-registered local trust, returned 13 per cent after its, lower, fee. AQR is quick to point out that the return has been higher and volatility lower than they’d assume over the longterm, as this has been an exceptional 12 months, though an exceptional 12 months that saw the opposite results for many existing hedge funds. The DELTA strategy is not hedge fund replication, Asness stresses, though it shares many of its goals. It invests in the same underlying instruments that the hedge funds represented in the main indices invest in themselves, rather than replicators who use a mix of high level investments, largely futures and a lot of cash, which happen to correlate to the indices (but not capturing the spirit of the actual strategies as DELTA does).