Research: Synthetic Funds Outperform Fund Of Hedge Funds

Nov 28 2006 | 3:14pm ET

Investors who want higher returns from hedge fund investments should fire their overpaid fund managers and replicate the funds themselves using mechanical futures trading strategies, according to new research from Cass Business School.

In a test involving almost 2,500 funds of hedge funds, Harry Kat, professor of risk management at the London-based school, shows that over the past 15 years, synthetic funds would have outperformed real funds of hedge funds 82% of the time.

“In the early days, the high fees came on the back of 15-20% returns,” Kat says. “Things are very different now; hedge fund returns are routinely around 6 – 7%, basically the same as a glorified savings account. If fund managers are taken out of the picture, however, returns can be boosted by 2 or 3%.”

Kat predicts the alternative investment market will rapidly move away from active management over the next ten years. “Twenty years ago active fund management in the traditional investment market was the status quo until someone came up with a system for managing funds through an index, doing away with the need for an active manager,” he says. “Index fund management now accounts for 40% of the traditional investment industry and I predict we will see a similar market share for synthetic funds ten years from now.”

Kat’s research shows that, using purely mechanical futures trading strategies, it is possible to design synthetic funds which generate returns with the same risk characteristics as funds of hedge funds.

“The significantly better returns gained by investing in synthetic funds confirm that efficient risk management and cost control tend to be much more certain routes to superior performance than trying to beat the market while paying excessive management and incentive fees.”

Kat argues that since synthetic funds only trade in the most liquid futures markets, they also avoid all the other typical drawbacks of alternative investments, such as the need for extensive due diligence, liquidity, capacity, transparency and style drift problems, as well as possible regulatory problems.

Kat and his colleague, Helder Palaro, have designed a ‘FundCreator’ system which tells investors how many futures contracts they need to buy or sell to create returns with the same statistical properties, such as volatility and degree of correlation with stocks and bonds, as a given hedge fund. While returns are in the hands of the investor, realistic back tests indicate that in some cases they can make a very respectable 10% average return per annum.


In Depth

Hedge Funds Take Interest In ‘Soft Deposits’

Nov 19 2014 | 11:56am ET

New York-based Winchester Equities, headed by Avi Benamu and Jack Hazan, funds soft...

Lifestyle

Cohen Buys $101 Million Sculpture

Nov 12 2014 | 9:17am ET

Steven Cohen was the sole bidder for a rare Alberto Giacometti sculpture at Sotheby...

Guest Contributor

Why The Big Money Is Going To Europe

Nov 14 2014 | 6:03am ET

Peer-to-peer lending was invented with the individual investor in mind. But despite...

 

Sponsored Content

    For Hedge Funds, Mastering Data Is Key To Success

    Nov 4 2014 | 9:45am ET

    Data management is important to every business, but for hedge funds, it is critical. FINalternatives recently asked Peter Sanchez, CEO of Northern Trust Hedge Fund Services, how fund managers can deal with the demands of managing data while at the same time remain transparent and abide by operational best practices. Read more…

Editor's Note

    Guidelines for Guest Articles

    Oct 22 2014 | 9:46am ET

    We are always looking for guest articles from hedge fund managers and buy-side firms.

    If you are interested in submitting a contributed piece for possible publication on FINalternatives, please take a look at the specs. Read more…

 

Futures Magazine

November 2014 Cover

Building a better market

Reg NMS created a huge bifurcation in equity markets and while much of what has followed has been positive, in terms of lower fees and greater liquidity, many traders would like to see the market come...

The Alpha Pages

TAP July/August 2014 Cover

The Alpha Pages Interview: Senator Rand Paul

Senator Paul sat down in the debut series of the Alpha Pages Interview to discuss the broken tax code, regulation surrounding Bitcoin, and his plans for the 2016 Presidential election.