Welcome to the Muppet Economy

Slipping back into my regular routine is sometimes a challenge after a few days of traveling. The first day back in the markets — especially following a week like we had to end July and begin August — can be a bit of an adjustment.

A few days away allows the accumulation of jaded skepticism to wane a bit. Hence, the surprise that registered this morning when I read a Wall Street Journal article on “How Individual Investors Can Invest Like a Hedge Fund.” The article goes on to look at three possible ways that an ordinary investor can deploy their capital “like a hedge fund without hefty expenses.”

What it failed to explain is why ordinary investors would or should want to do this.

About the best a small investor can do to achieve a “hedge-fund-like” stake is putting money in an alternative mutual fund, which engages in various forms of copycat investing. Fairly typical is a fund running a long-short investing strategy, betting on some assets increasing in price while others decline, and charging fees of as much as 4 percent of assets. Why anyone would be satisfied with this is hard to understand. Hedge funds have underperformed their broader benchmarks for one-, five- and 10-year periods. Consider the fact that this is a derivative of a style of a broader investment strategy, and not an asset class. These imitation hedge funds have underperformed the benchmark, namely, the hedge-fund index, which itself has underperformed the broader market. Perhaps we could call these new imitators “underperformers squared” or U2. So it has that going for it, which is nice.

The next attempt at flattery by imitation has the somewhat interesting name of “liquid beta.” I say somewhat interesting because unlike the exchange-traded funds that track indexes by paying a licensing fee to the owners of the index, the liquid-beta funds lack such access. Instead, they try to reverse engineer the holdings of hedge funds that do their darndest to keep their holdings private and their processes opaque. A cottage industry of quant backtesting of portfolios to try to simulate the desired trading strategy is underway. The proponents of this approach, who shall remain nameless, claim that this approach works surprisingly well. Color me skeptical until we have a decade or so of audited returns of both the target and the copy cat.

The name “liquid beta” made me chuckle. Trying to duplicate funds that have failed to create either alpha (above-market returns) or beta (market-matching returns) appears disingenuous at best, and evil marketing at worst.

Allow me to suggest that the name “negative alpha” is more descriptive of what these U2 funds actually offer.

In short, high fees and a suspect methodology that tries to imitate a class of investors that charge even higher fees for their underperformance sounds like a terrible idea for investors. But it’s just stupid enough and has enough impressive buzzwords that I have little doubt it will do well in the marketplace, attracting billions of dollars in dumb money.

In some Wall Street circles, customers who could be duped were referred to as “Muppets.” I have a feeling it’s a growth


Originally: Will You Become One of the Wall Street Muppets?


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