Hedge-Fund Returns Can Be Matched Without Fees, Professor Says posted on Tuesday 28 Nov 2006 05:09 GMT From Bloomberg - see full story Bloomberg reports that hedge-fund investors could earn greater returns at a fraction of the cost, according to research by Cass Business School Professor Harry Kat, who designed software to automatically mimic funds' trading profits. The article reveals that Synthetic funds would have outperformed 82 percent of the 2,000 hedge funds and 500 funds of hedge funds studied by Kat, a former head of equity derivatives at Bank of America Corp. Most of the gains generated by hedge funds were eaten up by fees, typically 2 percent of a portfolio and 20 percent of profits, he found after studying 15 years of monthly fund results.``In most cases, managers aren't good enough to make up for the massive fees that they charge,'' said Kat, a professor of risk management at Cass, part of London's City University, in an interview. ``The combination of excessive fees and minimal opportunity in the market makes alternative investments really doubtful in terms of their value for portfolios.''

Is Mr Kat able to reproduce alpha of, say, Renaissance Technologies?At least it's _not_ what he claims in here

1) First, I'm a bit skeptical that Dr. Kat's software will work as advertised with real money. There are a great many alpha-eating phenomena between simulated and real trading. I do wish him luck.2) That fees eat almost all the gains is sensible. In this world of copious data on performance, a fund need only poke through the risk-return efficient frontier by an iota to be exhalted for high performance. Even sitting on the frontier is good enough to be part of a successful peer group. Why should HF managers give away 1% more than needed in profit. If they are attracting new capital then, by definition, they aren't charging more than the market will bear. Nonetheless, I'd welcome the Wal-Martization of HF. If an aggressive cost-cutter wants to open up HF for the masses at a much lower price point, then more power to them. (Something tells me that few people will cry for the lost small-town mom-n-pop HF if a goliath Wal-Fund arises and takes both their customers and their alpha.)3) One of the rationale for hedge funds is in the "hedge" part of the name. Even if HF underperform on some absolute measure, their lack of correlation with other markets makes them a sensible part of a portfolio. As global markets have become more correlated, instruments such as HF have become more useful for diversification. In that regard, investing in HF is like investing in gold -- its not done for performance but for protection.4) As for Renaissance Technologies, I wonder if Renaissance Technologies reproduces the alpha of Renaissance Technologies. Moreover Renaissance Technologies is closed to new investors, is it not? If its closed, then its performance is a moot point. If I'm looking for where to put my risk capital, I must select from the set of open investments.

QuoteOriginally posted by: Traden4Alpha1) First, I'm a bit skeptical that Dr. Kat's software will work as advertised with real money. There are a great many alpha-eating phenomena between simulated and real trading. I do wish him luck.i share that scepsis. especially since his out-of-sample performance 1995-1999 showed an average -5% annualised profit for a 4 year period. not quite what one would expect from a hedge fund.

1995-1999 was a raging bull market in stocks. Hedge funds tend to do "poorly" during that type of scenario. Bear markets are when the hedge funds look "good".

oh really? the 'average' hedge fund returned about +18% annually in the mar'95-mar'99 period, and +5% in the '00-'02 bear market.(using CISDM index).sure, hedge fund returns are above equity returns in bear markets, and below equity returns in bull markets, but they tend to do better in bull markets than in bear markets. in any case, returning -4% per annum in a period when your peers returns over 14% (risk premiums) surely wouldn't satisfy investors who thought your strategy would mimic hedge fund returns?

Lepperbe-------- do your numbers include all types of trading strategies or equity-oriented only?

CISDM equal weighted. I think at the time equity related HF's accounted even for quite a bit less than today's index.Using CSFB/Tremont Index gives similar results.

Wonder what he'll do when hedge funds start buying puts on his indexes in order to hedge their tail risk.

Goldman sets up hedge fund cloneBy Steve JohnsonPublished: December 3 2006 19:43 | Last updated: December 3 2006 19:43Goldman Sachs has become the first bank to create a hedge fund replication tool in a move that could lead to a shake-up of the $1,300bn hedge fund industry.The platform will greatly undercut the notoriously high fees of the hedge fund sector. Those investing through a fund of funds can end up paying annual charges of 4-7 per cent, with up to 50 per cent of their returns eaten up by fees. Goldman will charge a flat 1 per cent.Goldman’s Absolute Return Tracker index (Art), is set to be among the first of a flood of hedge fund cloning products likely to be launched in a revolution being compared with the arrival of index trackers in the mutual fund world a generation ago. “There is a lot of dead wood in the industry – people who should not be running hedge funds,” said Harry Kat, professor of risk management at London’s Cass Business School, who has just launched his own hedge fund replication tool.“A lot of them will leave the business, because people are smartening up. Index replication is going to become as important as it is in traditional long-only investment, with 30-40 per cent of the market.”Replication strategies are based on academic research that suggests hedge fund performance is largely driven by movements in underlying markets, such as equity, bond and commodity prices, rather than the intrinsic skill of managers.Goldman has spent two years developing the algorithm that underpins its platform. The performance characteristics of thousands of hedge funds will be fed into the system monthly and Art is designed to decompose these data and calculate the aggregate position of the hedge fund universe. This position can then be replicated, potentially allowing Goldman to generate hedge fund performance at a fraction of the cost.Clones such as Art avoid the negative selection bias that bedevils existing investible hedge fund indices and funds of funds, due to the fact that few of the better hedge funds are open to new investment.It will be far more liquid, with trading available on a daily basis.“This may be ideal for any large institution that has been looking at hedge funds but doesn’t like the fact that it takes six months to put money [in] and to take it out again,” said Edgar Senior, executive director in Goldman’s fund derivatives structuring team.

Their ART model uses hedge fund data on a monthly basis. That gives a remarkable delay.

Instead of wasting their time developing a "mystery product", they should just have something that correlates 100% to the S&P-500.

Anybody a comment on Hedge ETS from New Star?