This will be tough

19 Feb. 2016
Author
Roberto Plaja

(Ri-Rf)t=alphai,t+βrm,t(RM-Rf)t + βsmb,tSMBt + βhml,tHMLt + βumd,tUMDt + єi,t

(Ri-Rf)t=alphai,t+βrm,t(RM-Rf)t + βsmb,tSMBt + βhml,tHMLt + βumd,tUMDt + єi,t

(Ri-Rf)t=alphai,t+βrm,t(RM-Rf)t + βsmb,tSMBt + βhml,tHMLt + βumd,tUMDt + єi,t

The issue of whether a manager is active or simulating activity in order to charge higher fees has been around for a while, not to mention whether both varieties produce results that justify those fees. Oddly, the first question is the harder to address: we know that by far the majority of managers, active or otherwise, woefully underperform their benchmarks after fees. Add to this how complicated it is to establish what counts for “activity” and you will be forgiven for wondering why do we still bother with the whole lot. (See this brief AAII Journal article, from which the above formula was taken; not exactly rocket science, but no easy-pickin’ for the un-initiated either.)

Recently we were blessed with two articles that touch on how to define active managers and, implicitly, what they should get paid. The first article indicates European regulators are piling-up on the matter with a vengeance (FT of February 15). While the discovery process moves along, consumer and investor protection groups are already requesting the disclosure of the names of the target fund managers: reminds me of the French revolution and how easily you could have ended up without a head. One of the dangers in all of this is that we risk to codify parameters which are not uniquely related or even useful to the task at hand, giving practitioners a clear way to rig the game in the future. Another is to make things so complicated no one will be better off for it: ultimately if the investor or client doesn’t get it what’s the use of the regulation?

Switching gears slightly, a group of managers usually thought of as activity personified, hedge funds, is under attack from a different animal. While regulators have yet to dream of the definition of active management in the area of alternative investments, the quants have rushed to fill the void. In the second article (FT of February 18) we are told that quants think hedge fund strategies can be replicated more economically with algorithms. This too is an old story which seems to be getting a second life (nothing works its magic better than a period of lackluster performance, and a mob of angry fee-paying investors). Someone quoted in the FT article gives us this pearl: “The hedge fund industry is bifurcating, between the ones that are truly active and those that merely generate alternative beta.” The implication is that alternative beta can be easily replicated – they are not called “quants” for nothing, maybe like the guy in the picture – and at a far cheaper cost than regular hedge fund fees.

All this fracas begs some questions. Buffett, is he an active investor or just a smart beta replicator (after all, he says he never sells)? Should compensation be related to the level of active risk or to the results obtained? How much should the compensation be? Is there skill in picking the right “factor” at the right time?

Told you. This will be tough.
The issue of whether a manager is active or simulating activity in order to charge higher fees has been around for a while, not to mention whether both varieties produce results that justify those fees. Oddly, the first question is the harder to address: we know that by far the majority of managers, active or otherwise, woefully underperform their benchmarks after fees. Add to this how complicated it is to establish what counts for “activity” and you will be forgiven for wondering why do we still bother with the whole lot. (See this brief AAII Journal article, from which the above formula was taken; not exactly rocket science, but no easy-pickin’ for the un-initiated either.)

Recently we were blessed with two articles that touch on how to define active managers and, implicitly, what they should get paid. The first article indicates European regulators are piling-up on the matter with a vengeance (FT of February 15). While the discovery process moves along, consumer and investor protection groups are already requesting the disclosure of the names of the target fund managers: reminds me of the French revolution and how easily you could have ended up without a head. One of the dangers in all of this is that we risk to codify parameters which are not uniquely related or even useful to the task at hand, giving practitioners a clear way to rig the game in the future. Another is to make things so complicated no one will be better off for it: ultimately if the investor or client doesn’t get it what’s the use of the regulation?

Switching gears slightly, a group of managers usually thought of as activity personified, hedge funds, is under attack from a different animal. While regulators have yet to dream of the definition of active management in the area of alternative investments, the quants have rushed to fill the void. In the second article (FT of February 18) we are told that quants think hedge fund strategies can be replicated more economically with algorithms. This too is an old story which seems to be getting a second life (nothing works its magic better than a period of lackluster performance, and a mob of angry fee-paying investors). Someone quoted in the FT article gives us this pearl: “The hedge fund industry is bifurcating, between the ones that are truly active and those that merely generate alternative beta.” The implication is that alternative beta can be easily replicated – they are not called “quants” for nothing, maybe like the guy in the picture – and at a far cheaper cost than regular hedge fund fees.

All this fracas begs some questions. Buffett, is he an active investor or just a smart beta replicator (after all, he says he never sells)? Should compensation be related to the level of active risk or to the results obtained? How much should the compensation be? Is there skill in picking the right “factor” at the right time?

Told you. This will be tough.

The issue of whether a manager is active or simulating activity in order to charge higher fees has been around for a while, not to mention whether both varieties produce results that justify those fees. Oddly, the first question is the harder to address: we know that by far the majority of managers, active or otherwise, woefully underperform their benchmarks after fees. Add to this how complicated it is to establish what counts for “activity” and you will be forgiven for wondering why do we still bother with the whole lot. (See this brief AAII Journal article, from which the above formula was taken; not exactly rocket science, but no easy-pickin’ for the un-initiated either.)

Recently we were blessed with two articles that touch on how to define active managers and, implicitly, what they should get paid. The first article indicates European regulators are piling-up on the matter with a vengeance (FT of February 15). While the discovery process moves along, consumer and investor protection groups are already requesting the disclosure of the names of the target fund managers: reminds me of the French revolution and how easily you could have ended up without a head. One of the dangers in all of this is that we risk to codify parameters which are not uniquely related or even useful to the task at hand, giving practitioners a clear way to rig the game in the future. Another is to make things so complicated no one will be better off for it: ultimately if the investor or client doesn’t get it what’s the use of the regulation?

Switching gears slightly, a group of managers usually thought of as activity personified, hedge funds, is under attack from a different animal. While regulators have yet to dream of the definition of active management in the area of alternative investments, the quants have rushed to fill the void. In the second article (FT of February 18) we are told that quants think hedge fund strategies can be replicated more economically with algorithms. This too is an old story which seems to be getting a second life (nothing works its magic better than a period of lackluster performance, and a mob of angry fee-paying investors). Someone quoted in the FT article gives us this pearl: “The hedge fund industry is bifurcating, between the ones that are truly active and those that merely generate alternative beta.” The implication is that alternative beta can be easily replicated – they are not called “quants” for nothing, maybe like the guy in the picture – and at a far cheaper cost than regular hedge fund fees.

All this fracas begs some questions. Buffett, is he an active investor or just a smart beta replicator (after all, he says he never sells)? Should compensation be related to the level of active risk or to the results obtained? How much should the compensation be? Is there skill in picking the right “factor” at the right time?

Told you. This will be tough.
May also be of interest
See all Insights →
May also be of interest
See all Insights →
May also be of interest
See all Insights →
Autorisation
Social Media
Navigation
Documents
Language
Switzerland
© SIMPLEWEALTH AG 2015 — 2022.
MADE WITH ❤️ IN BEAUTIFUL
Investing implies your capital is at risk. The value of your account depends on market movements and you may get back less than you invest.
Past performance is not an indicator of future performance. Unless otherwise specified, all return figures shown above are for illustrative purposes only and are not actual customer or model returns. Actual returns will vary greatly and depend on personal and market conditions.
Simplewealth AG is a Swiss-based advisory service, designed to assist clients in achieving discrete financial goals. We are not intended to provide comprehensive tax advice or financial planning with respect to every aspect of a client's financial situation and do not incorporate specific investments that clients hold elsewhere.
Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and Simplewealth AG charges and expenses.
Client securities accounts at Interactive Brokers LLC are protected by the Securities Investor Protection Corporation ("SIPC") for a maximum coverage of $500,000 (with a cash sublimit of $250,000) and under Interactive Brokers LLC's excess SIPC policy with certain underwriters at Lloyd's of London 1 for up to an additional $30 million (with a cash sublimit of $900,000) subject to an aggregate limit of $150 million. Futures and options on futures are not covered. As with all securities firms, this coverage provides protection against failure of a broker-dealer, not against loss of market value of securities. For the purpose of determining an Interactive Brokers LLC client account, accounts with like names and titles (e.g. John and Jane Smith and Jane and John Smith) are combined, but accounts with different titles are not (e.g. Individual/John Smith and IRA/John Smith). SIPC is a non-profit, membership corporation funded by broker-dealers that are members of SIPC.
All your investments are insured. Up to USD 500k
2
Investing in securities involves risks, and there is always the potential of losing money when you invest in securities. Before investing, consider your investment objectives and Simplewealth AG charge sand expenses.
How your assets can grow?
1