Ben Carlson and Nir Kaissar joined me on our “Behind the Markets” podcast last week. Ben is the Director of Institutional Asset Management at Ritholtz Wealth Management, writes a blog called “A Wealth of Common Sense” and just released a great new book, Organizational Alpha, that details best practices, questions and processes for institutions and their portfolio managers.
Nir Kaissar, columnist for Bloomberg Gadfly, is the founder and portfolio manager of Unison Advisors. Kaissar’s work focuses on quantitative approaches to multi-asset portfolios, such as valuation- and momentum-based methodologies. He introduced one of the first multi-asset investment managers in 2005 and mentioned to me that he has one of longest and (to his credit) one of the better track records in the multi-asset model business.
Hedge Funds vs. Market Bet
Coincidentally, I had booked these gentlemen for the show weeks ahead of time. But on March 17, Kaissar wrote on Twitter: “Who wants to bet me that hedge funds will beat the S&P 500 over the next 10-years?”
His bet is modeled after Warren Buffett, who bet Protégé Partners $1 million dollars that the S&P 500 would beat a group of fund of fund hedge funds.1 That bet is coming to a close in the next 12 months, and by most accounts, Buffett seems likely to win his bet handily.
Kaissar’s bet is for more modest and friendly stakes: the loser has to buy a beer a decade out. Ben Carlson took him on by taking the Buffett side.
Kaissar believes today’s market valuations—and he points to the cyclically adjusted price-to-earnings ratio (CAPE) as one of the points that could be a drag on future returns. He and I discussed the pitfalls of the CAPE; Kaissar still has subdued expectations for U.S. market returns, and he sees strong correlations between valuations and forward-looking returns.
Carlson, on the other hand, admits that this bet might be tougher than Buffett’s. But he thinks the hedge fund universe has many challenges. Apart from the $3 trillion invested in them and 11,000 funds all competing over limited alpha opportunities, he believes hedge funds are a “cash-plus” asset structure. What he means by that is that hedge funds would typically and historically have shorted assets and invested the proceeds in cash assets that earned a return—usually 4%–5% throughout history. Now, with short-term rates near zero, hedge funds get less earnings on those “short” proceeds. A rising-rate environment thus may help hedge funds a little, but Carlson isn’t expecting rates to rise much.
The gauge for tracking the performance of hedge funds over the next decade in this Carlson vs. Kaissar wager is going to be the HFRI index. The HFRI index is a composite of hedge funds; this includes the typical asset management and performance fees for hedge funds—so Kaissar has to see the funds overcoming probably a close to 300-basis-point (bps) expense hurdle rate just to break even with the S&P 500. As it is currently framed, I have to say I am on Carlson’s side of Kaissar’s bet.
A Tougher Challenge
But a follow on: One no longer needs to use high-cost hedge funds to get a simple hedged strategy for U.S. equities. As both Carlson and Kaissar discussed on the podcast, there are new liquid alternative strategies that attempt to systematize hedging programs with a rules-based factor process. WisdomTree, in fact, has such a long/short, dynamically hedged equity strategy.
While I would side with Carlson and choose the S&P 500 over the HFRI index (hint to Kaissar if he wants more action on their original terms), I would offer the same terms to Carlson, with the choice of a different benchmark: the S&P 500 versus the WisdomTree Dynamic Long/Short U.S. Equity Index.
Here there are no underlying hedge fund fees, so it’s just strategy index vs. strategy index. Over the next decade, will it prove advantageous to have been long-only in market cap-weighted indexes with no hedge or in a factor-tilted long portfolio with a dynamic hedge of market risk? In my fully biased opinion, the WisdomTree Dynamic Long/Short U.S. Equity Index benchmark would make it more difficult for Carlson to prevail.
The podcast touched on many areas outside this bet as well, so don’t let this keep you from listening to other interesting areas, including topics such as:
- Why Carlson wrote Organizational Alpha, and the pitfalls of many institutional investing groups
- More discussion on alternative strategies and the challenges for institutional managers in picking winners
- The challenges of group decision-making processes and how to overcome them
- How Kaissar looks at asset allocations across stocks, bonds and cash and where the opportunities are today. If you cannot tell already from his subdued view of U.S. equity markets (above), they are outside the U.S. markets, particularly in emerging market equities.
Enjoy the full podcast here, and thanks to both Nir Kaissar and Ben Carlson for joining us on the broadcast!
1On that bet, see Roger Lowenstein, “Why Buffett’s Million-Dollar Bet Against Hedge Funds Was a Slam Dunk,” Fortune, 5/11/16.