Guy Figures Out How To Put Hedge Funds Out Of Business Once And For All

As we’ve noted, this year hasn’t been a particularly good one for hedge funds. In fact, it may (or may not) be the beginning of the end for them.

Unfortunately for those of us who have enjoyed the antics of the erstwhile Masters of the Universe over the years—the demolition of perfectly good beach houses, out of spite or otherwise; the pet pigs, piano-playing or otherwise; the Zamboni machines; the Spiderman undies; the declarations of war on sovereign nations—someone may have finally figured out how to put the final nail in the hedge fund coffin. Certainly, Joachim Klement’s credentials check out. He’s the former head of UBS Wealth Management’s strategic research team, as well as a former equity strategist there. He used to run a fund consultancy. He’s got a couple of master’s degrees. He’s a trustee of the august-sounding CFA Institute Research Foundation. He seems like the real deal. And here are his few simple rules for building your own above-average hedge fund with a few minutes' work every month:

At the beginning of each month, I sold a one-month put option on the S&P 500 index that was about 1% out of the money. The exact rule varies a little bit, because I set the strike one tenth of the monthly volatility of the S&P 500. This way, the put option will be a little further out of the money if volatility is high, and a little bit closer to the current index reading if volatility is low. The money I would normally invest in hedge funds I simply put into a one-month Treasury bill.

After one month, this strategy has earned the interest on the Treasury bill and the premium on the sold put option. Of course, if markets go down, I will have to pay money on the put option that expired in the money, which reduces the return of the strategy. This simple procedure is repeated each month.

Now for the bad news:

The result is an investment strategy that performs better than the average hedge fund net of fees, and with lower fees overall.

And now the really bad news:

The similarities between the put selling strategy and the performance of the average hedge fund diverged in 2011. Since then, the average hedge fund has performed even worse than the put selling strategy after 2% costs. This is the very best dumb alpha can offer: a simple, low-cost investment method that outperforms more sophisticated and expensive strategies.

Sometimes one can have the cake and eat it too.

Or cry in one’s soup in mourning for one’s lost fee income.

Dumb Alpha: How to Build an Above Average Hedge Fund [CFA Institute Enterprising Investor]