So-called alternative hedge-fund beta allows investors to gain the returns generated by hedge-fund strategies without the pressures of finding alpha, says Fama family professor of finance at the University of Chicago Booth School of Business, Tobias Moskowitz.
Moskowitz says there are three components to hedge fund returns: alpha, or the unique skills of managers; broad market returns or beta; and “something else” that he calls alternative hedge-fund beta: the common risk and reward exposures shared by hedge funds.
Over time, the alpha that hedge- fund managers deliver has been shrinking, he says.
“Betas are larger than market- neutral or absolute-return managers claim,” Moskowitz says. “Alpha as a concept has shrunk, but the opportunity set is still the same.
“If you look at what’s inside hedge funds, there are some hedge funds with unique alpha. There is also a lot of traditional market beta, but there is also something in between. This alternative beta gives you access to alternatives without having to find the alpha.”
Alpha, beta and the data
Hedge-fund managers are paid to deliver alpha, but Moskowitz thinks the returns of hedge funds are highly correlated and he questions what investors really pay for.
“Alphas are smaller than average returns, [so] you’re paying fees for index-fund components,” he says.
What investors want from hedge funds – and pay for – has not always been delivered. For example, over the past few years absolute-return indexes 0.83 have been closely correlated with the MSCI World Index of global stocks.
The correlation of the Credit Suisse Tremont Hedge Fund Index with the MSCI World over the past five years was 0.83
The Credit Suisse Tremont Hedge Fund index, a gauge measuring the returns of 10 hedge-fund strategies, has a correlation with the MSCI World of 0.83 over five years.
Its correlation with the HFRI Hedge Fund Index is 0.91.
“Finding historical alpha is easy, but finding future alpha is very difficult,” Moskowitz says.
“People spend too little time on whether they have the right betas, and too much time on alpha.” Alpha and beta are tools investors can use to achieve higher rewards with lower risk. But investors often get confused by the jargon, he says.
Furthermore, the alphas and betas in hedge funds are hard to measure because funds report returns themselves, the illiquid instruments that are used and the lack of transparency.
A way to access alternative hedge- fund risk premia – the common risk factors associated with alternative or hedge-fund strategies – is through futures contracts based on underlying indexes and stocks, and those used to hedge particular risks, such as the movements of interest rates and currencies.
“Simple managed-futures strategies capture a significant portfolio of manager returns,” Moskowitz says.
This can be achieved by running simple managed-futures strategies across multiple asset classes, and regressing the returns of the largest managed-futures managers and indexes on those of the strategies.
“This applies a systematic quant style to a set of diversified and liquid instruments with trades triggered on trend following or momentum signals,” he says.
Moskowitz, who also holds a research associate position at the National Bureau of Economic Research, is an adviser to AQR Capital Management, which has $2.4 billion of its $47.5 billion in managed-futures strategies.