Seeking Alpha – Sailors out there will know that boats can sail down with the wind – like a leaf being blown across the water – or into the wind at an angle, zigzagging back and forth along the way. Sailing downwind is easier and since it offers a direct path from A to B, and is therefore faster. Zigzagging directly upwind, on the other hand, requires more skill and is much slower. But who would want a boat that could only sail along with the direction of the wind? This is where sailing can offer a useful lesson for hedge fund investors.
Since the beginning of the last bull market, questions have been raised about the high correlation between hedge funds and equity markets. Arguably, this relationship gave birth to the field of hedge fund “replication” (a field that now involves a wide variety of “alternative” betas as well).
But all along, hedge funds have said that when markets rise, why shouldn’t they try to capture all this upside – and then some? The value in alternative investments comes not necessarily from their consistent absolute outperformance, but in the option-like behaviour of their returns. In other words, your “2 and 20″ buys you a market put. Long-only managers, hedgies are apt to say, simply don’t have the ability to make dramatic adjustments to net exposure in response to market gyrations.
