
The Hedgie in Winter - kolbe
https://www.aqr.com/Insights/Perspectives/The-Hedgie-in-Winter-
======
paulsutter
Institutional investors want consistency more than they want returns. Career
risk is a bigger concern than your retirement balance.

In turn, hedge fund traders are paid for returns, but fired for volatility.
Firms like Point72 literally have a "down and out" clause in their contract:
if you have a certain percent drawdown you will be fired. Internally, hedge
funds backtest against measures such as IR (information ratio) and not against
returns. IR penalizes for volatility and rewards consistency.

[https://www.investopedia.com/terms/i/informationratio.asp](https://www.investopedia.com/terms/i/informationratio.asp)

~~~
throwawaymath
_> Internally, hedge funds backtest against measures such as IR (information
ratio) and not against returns. IR penalizes for volatility and rewards
consistency._

Hedge funds are not a homogenous enough group to make a blanket statement like
this.

~~~
echion
All generalizations are over-generalizations?

GP is a fair comment, actually: nobody that knows anything about how risk
works wants to see a returns number. If a fund doesn't backtest against IR, or
penalize for volatility, it's not going to be getting significant investments.

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ackbar03
Seems like a slightly simplified study but I think it does highlight a
pervasive problem. There's too much money chasing increasingly limited
strategies. Things like start-arb and momentum used to be pretty new and
relatively obscure 10 years ago but now your every-day retail trader has
probably heard about them and your friendly neighbourhood data-service
provider includes all sorts of factor indices as a package.

I used to be a trader at a bank, the entire field/discipline of trading is a
gross distortion in terms of the work they do and what they are compensated.
The increasing competition sort of makes it even more twisted, the amount of
effort and technology being used to squeeze out returns and enrichen these
fund managers doesn't really make sense to me.

I think this post (not very objective or scientific to be citing quora but I
think it gives good insight) sort of shows the kind of brain drain finance has
on society.

[https://www.quora.com/Do-hedge-funds-use-the-generalized-
met...](https://www.quora.com/Do-hedge-funds-use-the-generalized-method-of-
moments)

These are really smart people staring at mostly random price data all day and
applying increasingly obscure techniques to eek out a signal just so they can
squeeze some money out of the guy at the other end. Why????

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georgek
For context, the title is a reference to the play, "The Lion in Winter"

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jgalt212
> Nobody has ever marketed a fund or asset class with the tag line “we’ll
> likely tread water net, which is actually pretty impressive after we take
> out our massive fees.” But it’s not nearly the disaster that’s so often
> claimed.

So it's not theft or fraud, just merely a wealth transfer from the investors
to the managers.

~~~
jmagaro88
Hedge funds are not pro bono. People are still doing their jobs, and most
funds are not run solely on a percentage of profit basis.

~~~
jgalt212
true, but the implication is that if fees were lower then returns for
investors would be better than treading water. i.e. an actual service is
performed rather than a straight wealth transfer

~~~
a_t48
The investors are welcome to do that work themselves.

------
mlthoughts2018
The article is advocating that the only appropriate counterfactual investment
to compare to a hedge fund investment would be a long-only equity portfolio
constructed to bear the same exposure to the overall market as the hedgefund
portfolio (this exposure is called beta), and later extends this to a
regression that controls not only for the level of beta but also the level of
the same old dumb shit Fama-French factors (well, just SMB) that people keep
head-in-the-sand believing are important.

The regression analyses are sort of just technobabble. They very much fall
absolutely into the class of so-called “garbage can regressions” — assuming a
linear link function is roughly physically realistic, then just dump shit in
on the right hand side and assume, unilaterally and for no good reason, that
summary statistics like t-stats & r-squared faithfully indicate confidence in
the interpretability of the fitted model, without any attempt at accounting
for non-linearity, interaction terms, or random effects (situations where the
coefficient ought to vary by different subgroups due to stratification
inherent to the data).

Even for comically simple cases, you can show that when these aspects are
unaccounted for you can get effect sizes _with the wrong sign_ that are
simultaneously _hugely statistically significant_ , see [0].

Active managers use this simplistic regression technobabble to slice and dice
datasets, cherry pick time periods or asset groups or quantiles of exposures
to any number of conveyor belt covariates from accounting data, news data,
whatever (and, hilariously, _all_ of them are using the same third-party data
vendors and constructing the same models with the same factors -- so the
modeling is surely not any form of differentiator or comparative advantage...
cough marketing cough).

And, just like here, they work extremely hard on arguing disingenuously for
what baseline they're supposed to be measured against.

But the money quote is:

> “Traditional active funds do much worse than hedge funds over the full
> period but, unlike hedge funds, they don’t deteriorate in the second half of
> the sample (they just continue to consistently underperform both the market
> and hedge funds but at their normal pace of underperformance).”

So, given this, why shouldn’t someone consider a broad market index as the
correct counterfactual investment. If it’s obvious (and I think by now it is)
that active asset managers & mutual funds just consistently underperform while
also taking active management fees, why wouldn’t someone view their
counterfactual option as a super low fee ETF that tracks a broad equity index?

What matters is _what I could have invested in._ Whether that is my idiot
nephew’s idea for flying toaster drones or a sophisticated hedge fund product.
And the more you tell me that a class of investments defined by characteristic
exposures to e.g. the market index or SMB consistently underperforms, the more
reason I have to believe there’s no skill there, and to question whether my
counterfactual investment really needs to have a constraint on particular
exposure to these characteristics— maybe it just means to the extent that
hedge funds look like low-beta strategies, the hedge funds are stupid, and I
shouldn’t have been on the market for the hedge fund’s advertised
characteristics in the first place.

It’s actually kind of amazing that Cliff Asness can write a head-smacking
quote like that right on the AQR website and _probably be rewarded for it_
with a bunch of protect-my-ass board members from pension funds voting to give
AQR more money _for telling them that AQR itself is systematically unskilled
at this._

What a world.

[0]: <
[http://www.columbia.edu/~gjw10/achen04.pdf](http://www.columbia.edu/~gjw10/achen04.pdf)
>

