Be prepared for the coming revolution in the Hedge Fund industry

Will hedge funds follow the path of passive investing, just as the traditional fund management industry did a generation ago?

The hedge fund industry is slowly beginning to acknowledge that a large part of its returns comes not from alpha, but from “alternative beta” factors – systematic exposures to a diverse array of risk premia including credit risk, volatility risk, the small company effect and so on.

One of the key implications of “alternative beta” theory is that it is possible to create “synthetic hedge funds”, which replicate the alternative beta exposures of hedge funds. The aim of these funds is to generate hedge fund-like returns without hedge fund fees.

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"An event not to be missed, shedding light on the true nature of the hedge fund world" Gianluca Oderda, Head of Multi Assets and Total Return, Pictet Asset Management SA

Hedge fund returns without hedge fund fees?

Two Swiss institutions, Partners Group and AlphaSwiss, have been early pioneers in this field, running “alternative beta” funds for over a year. But in the last few months, some of the world’s largest investment institutions have announced the launch of their own synthetic hedge fund products. Merrill Lynch has launched the Merrill Lynch Factor Index, Goldman Sachs has unveiled “ART”, its absolute return tracker, and in February 2007, JP Morgan announced the launch of “ABI”, its Alternative Beta Index. Other large institutions are urgently working on product development in this area, heralding the emergence of a new generation of hedge fund products.

A new era of passive investing for the hedge fund industry

These recent developments mirror those which took place in the traditional fund management industry, some 20 years ago, when indexed tracker funds were introduced. The initial take-up was slow, but in time these mechanistic funds, with their lower fees, gained a significant market share. Will hedge funds now also follow the path of passive investing? The technology is far more complex, but the major players appear to believe it can be done. Clearly, the stakes are huge.