Andrew Beer This article was authored by Andrew Beer, founder of Beachhead Capital Management LLC in New York.
A vexing issue with hedge funds is the lack of persistence of returns. Last year’s winners generally are no more likely to be this year’s. Consequently, while quantitative screening tools help investors to identify strong historical performance, they are of little use in determining which funds will perform better going forward.
Beachhead’s proprietary research demonstrates that, while alpha overall does not persist, "tactical" alpha does. Broadly speaking, hedge fund alpha can be broken down into two sources: position alpha and tactical alpha. Position alpha represents outperformance due to security selection, illiquidity and other factors, such as optionality. Tactical alpha represents medium-term relative value trades across asset classes – such as investing in credit post-crisis or shifting back to developed markets equities in 2012-13.(1) Both position alpha and tactical alpha have a low correlation to equities over time, and hence are valuable diversifiers.
In order to study the persistence of tactical alpha, we examined the performance of 679 funds over the seven-year period from 2007 to 2013. The key conclusions are as follows:
• Managers that generated high tactical alpha (top quintile) in a given year outperformed the overall pool by 246 bps per annum on average in the following year.
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