In the future we won't pay much for exotic betas. We'll pay for superior human intellect instead. We'll know the difference because we'll abandon simpleminded performance benchmarks, like peer groups and indexes, and replace them with smart science. Disruptive innovation will elevate our comprehension and contentment.
Researcher -- R: Hello Mr. Hedge. Thank you for attending our due diligence meeting.
Hedge -- H: You're welcome. I hope this is quick. I have serious thinking to do. I am a genius you know. You are lucky to meet me.
R: Indeed. I can see the brilliance pulsating from your enormous cranium. I'll keep this brief.
Our probes have analyzed your trading history and concluded that you are dollar neutral, investing long in value stocks, and shorting growth stocks. If this is correct we'll send in the clones.
H: Yes, that's correct, but what is this clone thing?
R: Our microprocessor replicates most of the trading decisions you could have made through time. It creates thousands of cyberclones that manage money the way that you do. They live & breathe in cyberspace. Everyone loves a clone.
You remember the hedge fund epiphany that we had way back in 2015. We abandoned the absurdity of hedge fund peer groups and replaced them with the science of hypothesis testing. We compare your performance results to all of the possible returns you could have earned when implementing your strategy. Cybercloning is like those old simulation apps that everyone used to play on their smart phones, like beat-the-monkeys and dartboard --decisions. We want to see if you can outperform the majority of your random cyber competitors. If not, we can replicate you for free. Better living through science.
H: Fascinating. Let's clone around.
R: You've succeeded in beating 75% of your cyberclones. Congratulations. Based on these results, we can pay you 15 basis points plus a performance-based fee of 5%.
H: But I charge a 2% fee -- 200 basis points -- plus an incentive fee of 20%.
R: Yes, I know. We will not pay that fee because if we do we are likely to lose money. You're good, but not good enough to warrant your standard fee. Our offer is firm. I have the authority to say so.
H: How about a 20 basis point fee and a 15% incentive? I'll even throw in a holographic entertainment suite just for you. It's the bomb.
R: Nice try, but no.
H: OK, we have a deal. You drive a hard bargain, but I'm a genius so I recognize your offer is fair. We'll both be happy. Thanks for your business.
Just one more thing. Can I bring a cyberclone home with me please? They're cute. They remind me of me.
R: I'll transmit several cyberclones to your work pod. Enjoy. Feed them ideas and they'll last a long time.
H: Thanks. And one more question. What exactly do you mean by the "absurdity of hedge fund peer groups?"
R: The very thing that makes hedge funds attractive makes them impossible to group together. Hedge funds are unique. That's their main attraction. The definition of unique is "without peers," so we cannot group unique. For example, grouping long-short managers into a peer group is absurd because each manager has his own unique approach long and his own unique approach short. A manager can be long value stocks and short growth stocks, or long corporate bonds and short government bonds; he can use leverage, derivatives, etc. You can confirm the absurdity by calculating the cross-correlations of managers in a hedge fund peer group. You'll find that performance correlations are very low, demonstrating that these so-called peers are not at all alike.
It is this uniqueness that led us long ago to the science of hypothesis testing and the simulation power of cyberclones. No one wants or needs to pay for complex betas (pronounced bay-tahs), but everyone is willing to pay for that critical factor they can't engineer on their own, namely superior human intelligence and wisdom that engender profitable decisions.
We have come a long way, and are much smarter and happier because of it