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July 10, 2009

Professional Asset Manager Performance: Are you Getting What You are Paying For???
by Reggie Middleton

In case you haven't noticed, I am pretty much anti-establishment. In keeping with that streak, I feel obligated to highlight the sham that is the global asset management industry. Many high net worth individuals and institutions pay big fees to alledged geniuses to essentially have their money sit in the stock and bond markets. Here's a surprise, you can do that for free. Hedge fund performance basically tracks the performance of the stock markets, particularly in the US. There is a small amount of alpha generated, but relatively little in comparison to what is marketed and publicized. Granted, a little alpha is better than none, but that is not necessarily what the alternative asset class mantra preaches, is it?

The results of this blog and my proprietary trading accounts run circles around hedge fund results, multiple circles. Granted, I had a bad quarter, and that bad quarter was sandwiched between two calendar quarters, which pulled on the performace of two (calendar-wise) quarters, but that was nothing but giving back some profit due to my underestimating the extent to which news flow and markets were to be manipulated by the powers that be while being net short. I knew it was coming, I just significantly underestimated the extent. Even so, BoomBustBloggers should be running circles around the crowd. I will release new performance figures at the end of this quarter to see how we stand (the most recent ones were from March). To date, my valuation, forensic and macro calls have been on point for two years running. It appears there are some who don't understand that prices can, and often, diverge from fundamental valuations - but despite that, fundamentals ALWAYS win in the end. That is how you make money. When something is mispriced, you take a position in it and wairt for reality to hit. Those that have a problem understanding that are usually the hot money crowd.

See The Great Global Macro Experiment, Revisited for more on my investment style, and click here for historical performance posts and towards the latter portion of 2008 - Updated 2008 performance. You can download a model that will give you an idea of performance for all but the latest research, which as I mentioned earlier had a bad quarter (you will have to search the site for it, I will post the link in the comments section once I find it). The most recent tabulated results are here: BoomBustBlog Performance, year to date.

About 35% to 45% of those returns (profit) were given back in the recent bear rally, but this still leaves competition dominating performance. I am also quite confident that the upcoming quarters will be quite profitable for my bearish research, recouping if not besting the top line numbers from the March tabulation. It has become quite obvious that one must be fairly prolific trader through the bear market rallies, and that is not my cup of tea. I find trading to be laborious and time consuming, but the volatility and apparent market manipulation forces one, even one such as I, to take shorter duration positions than would normally be necessary.

As the research and ideas have gotten more complicated, I will have to institute a new, more realistic method of tabulating results for distributing through the blog. The buy and hold concept unfairly skews results downwards in an envrironment when a real investor is forced to trade more often. My dilemma is that I don't want to give the impression that I am soliciting through the proffer of results. I'll have it figured out by the time I retabulate results.

Now, about those other professionals...

We have analyzed hedge fund performance by computing hedge fund alpha in both down trending and up trending markets. We used Barclay's Hedge Fund Index as a proxy for hedge fund performance. To compute alpha (Rp-Rb) we have used S&P 500 index as the benchmark index. In addition to alpha we have also computed tracking error and information ratio to give additional insights relating to hedge fund performance during up trending and down trending markets.

The table below presents performance of hedge fund over the past five years (since June 2004) based on monthly returns.

Down trending markets

As stated previously on an absolute basis, hedge funds do not perform well during down trending markets with negative mean return of 1.22% (monthly) during down trending markets. However, on a relative basis, hedge funds have outperformed S&P during down trending markets with median alpha of 2.42%.

Since June 2004 S&P have yielded negative monthly returns during 24 occasions (categorized as down trending markets). Of these 24 months on only 9 occasions hedge funds have yielded positive returns (i.e) only 38% probability of generating positive returns during down trending markets.

On 22 of these 24 occasions hedge funds have outperformed S&P on a relative basis generating positive alpha (i.e) 92% probability of generating positive alpha during down trending markets.

Information ratio of hedge funds during down trending markets at 0.84x is considerably higher than overall information ratio of 0.12x (all periods since 2004) and -0.29x during up trending markets.

Up trending markets

During up trending markets on absolute basis hedge fund tend to perform better with an average monthly return of 1.50%. However, on a relative basis, hedge funds do not perform better during up trending markets with median alpha of -0.49%.

Since June 2004 S&P have yielded positive monthly returns on 37 occasions (categorized as up trending markets). Of these on only 3 occasions hedge funds have yielded negative returns (i.e) 92% probability of generating positive returns during up trending markets.

However on only 13 of these 37 occasions hedge funds have generated positive alpha (i.e) 35% probability to generate positive alpha during up trending markets.

Information ratio of hedge funds during up trending markets is negative (-0.29x) suggesting that hedge fund managers add no real value during up trending markets.

Overall performance

Overall mean monthly return of hedge funds is 0.43% compared with -0.22% of S&P 500 with median alpha of 0.36% and mean alpha of 0.65%.

Tracking error of hedge fund is 2.92% with a low information of 0.12x, implying that hedge fund managers add very little value through their active management strategies.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

Who am I?

Well, I fancy myself the personification of the free thinking maverick, the ultimate non-conformist as it applies to investment and analysis. I am definitively outside the box - not your typical or stereotypical Wall Street investor. I work out of my home, not a Manhattan office. I build my own technology and perform my own research - in lieu of buying it or following the crowd. I create and follow my own macro strategies and am by definition, a contrarian to the nth degree.

Since I use my research as a tool for my own investing to actually put food on my table, I can stand behind it as doing what it is supposed too - educate, illustrate and elucidate. I do not sell advice, I am not a reporter hence do not sell stories, and I do not sell research. I am an entrepreneur who exists just outside of mainstream corporate America and Wall Street. This allows me freedom to do things that many can not. For instance, I pride myself on developing some of the highest quality research available, regardless of price. No conflicts of interest, no corporate politics, no special favors. Just the hard truth as I have found it - and believe me, my team and I do find it! I welcome any and all to peruse my blog, use my custom hacked collaborative social tools, read the articles, download the files, and make a critical comparison of the opinion referencing the situation at hand and the time stamp on the blog post to the reality both at the time of the post and the present. Hopefully, you will be as impressed with the Boom Bust as I am and our constituency.

I pay for significant information and data, and am well aware of the value of quality research. I find most currently available research lacking, in both quality and quantity. The reason why I had to create my own research staff was due to my dissatisfaction with what was currently available - to both individuals and institutions.

So here I am, creating my own research for my own investment activity. What really sets my actions apart is that I offer much of what I produce to the public without charge - free to distribute and redistribute, as long as it is left unaltered and full attribution is given to the author and owner. Why would I do such a thing when others easily charge 5 and 6 digits annually for what some may consider a lesser product? It is akin to open source analysis! My ideas and implementations are actually improved and fine tuned when bounced off of the collective intellect of the many, in lieu of that of the few - no matter how smart those few may believe themselves to be.

Very recently, I have started charging for the forensics portion of my work, which has freed up the resources to develop the site to deliver even more research for free, particularly on the global macro and opinion front. This move has allowed me to serve an more diverse constituency, which now includes the institutional consumer (ie., investment turned consumer banks, hedge funds, pensions, etc,) as well as the newbie individual investor who is just getting started - basically the two polar opposites of the investing spectrum. I am proud to announce major banks as paying clients, and brand new investors who take my book recommendations and opinions on true wealth and success to heart.

So, this is how I use my background and knowledge in new media, distributed computing, risk management, insurance, financial engineering, real estate, corporate valuation and financial analysis to pursue, analyze and capitalize on global macroeconomic opportunities. I have included a more in depth bio at the bottom of the page for those who really, really need to know more about me.

Visit his blog Boom Bust Blog.

Copyright © 2007-2009 Reggie Middleton

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