Clearly this gives investors another level against which to judge their high-cost hedge fund managers, and arguably one that is much more suitable than comparisons to cash or to market-capitalisation weighted benchmarks. JPMAM looked at six different types of events that typically constitute event driven investing (including merger arbitrage, index reconstitution arbitrage, share repurchases, conglomerate discount arbitrage, activist investing and post-reorganisation equity) and found the combination could explain a significant proportion of the performance of the broad HFRI EventDriven index. When applying a fee of 1% base and 15% performance fee, the returns of JPMAM’s combined index fell almost perfectly on top of the HFRI index.
However, when applying a fee level that is more realistic for an alternative beta product, rather than full-blown hedge fund fees, the returns were considerably better than the HFRI index.
SMARTER THAN AVERAGE
Of course, the HFRI Event Driven index tracks the average hedge fund manager in the space, but no investor sets out to appoint an average manager. The relative outperformance of JPMAM’s index after fees would therefore appear to be a much better barometer by which to assess the ability of a manager to add genuine alpha. The idea of using alternative beta indexes to measure hedge funds’ value add is not lost on investors.
Beachhead’s Beer says: “When hedge fund fees consume 80% of alpha, they are at least double what they should be. The replication movement has focused attention on this.”
In the CTA space, for example, the advance of alternative beta strategies has had a meaningful impact on fees because of the ability to better identify genuine alpha.
Alternative beta strategies that track momentum are “very similar” to CTAs, according to Matthew Towsey, principal in Aon Hewitt’s liquid alternatives research team. “Alternative beta sheds a lot more transparency on what hedge funds are doing in some areas. Investors can look at the performance of a strategy charging 50 – 100 basis points and compare that to a CTA, which should be adding value after fees on top of the alternative beta strategy,” he says.
The impact of alternative beta on the CTA space has certainly been marked, both in terms of fees and new launches, and demonstrates the challenge these new products are posing to hedge funds. Data from Preqin shows since 2009 CTA management fees have fallen from 1.76% on average to 1.53%. Between 2010 and 2016 performance fees fell from 22% to 19.4%.
Since 2012 the number of CTA new launches has plummeted. 2012 saw 155 launches across managed accounts, commingled structures and liquid alternatives (alternative beta). By 2015, that total was down to 98, with managed accounts taking the biggest hit as the number of launches more than halved. 2016 had seen only 23 launches at the time of writing.
Meanwhile, the proportion of CTA launches accounted for by liquid alternative strategies has crept up, more than doubling from 8% in 2009 to 17% in 2016. “A lot of what hedge funds provide is a noisy combination of traditional market returns, which no one should be paying high fees for, alternative beta, which investors should be paying less than hedge fund fees for, and alpha,” says Ronen Israel, head of the global alternative premia group at AQR, one of the original pioneering firms of the alternative beta space.
“Over time, alternative beta raises the bar on evaluating managers and their value add,” he continues. “That puts pressure on fees and other investment terms, and whether managers are able to survive if they are not able to show that they add value in a truly idiosyncratic way.”
