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Wisdom on Beating the Market

August 12, 2011 | About:

A volatile market is probably here to stay. But those hedge funds that can navigate this difficult market and move beyond following the beta (that is returns affected by broad stock market) and increase their active return/active risk from alpha drivers, would attract investors' interest.

Active return is the return earned on an active investment vis-à-vis to a benchmark. Active risk is a type of risk created when the fund attempts to outperform a benchmark. A study of traditional large-cap equity funds reveals that the manager’s returns replicate those of S&P 500. This means the fund managers' returns are correlated linearly with the stock market (beta of 1, and correlation coefficient of 0.99).

See Reminiscences of a Stock Operator” Cheat Sheet Part 2 where I talked about Livermore’s wisdom on beating the stock market.

A man may beat a stock or a group at a certain time, but no man living can beat the stock market! A man may make money out of individual deals in cotton or grain, but no man can beat the cotton market or the grain market. It’s like the track. A man may beat a horse race, but he cannot beat horse racing.

Remarks: Read the article Debunking 5 Myths of Stock Investing where I wrote, “Superstar hedge fund managers are ephemeral. What does that tell you about being invested in the market?”

Alpha drivers are chosen as part of tactical asset allocations to achieve returns beyond those offered by passively managed funds. Few alpha drivers include market neutral funds, commodities, merger arbitrage, event driven, etc.

In this volatile market, almost no one is immune from losses. Read more here: Exclusive: Oil trader Hall's fund down 10 percent in early August.

The main commodity hedge fund of Phibro oil trader Andrew Hall has lost about 10 percent of its value so far this month after oil prices plunged on global economic fears, people familiar with the fund said Thursday.

Hall's flagship Astenbeck II fund is now flat for the year after its latest slide -- and earlier slumps in May and June -- wiped out gains made in the first quarter, when oil prices rallied, according to two hedge fund industry sources.

Billionaire trader John Paulson -- famed for his big winning bets against the collapse of the U.S. housing market in 2007 and a surge in gold prices thereafter -- is emerging as one of the year's biggest losers, with his Paulson & Co firm worth just around $35 billion last week compared to around $38 billion in March.

Other major fund managers like Steve Cohen and Bill Ackman have also taken steep losses for August.

Hall, who made headlines for receiving a giant $100 million bonus while at Citigroup (C.N), also has served as the head trader at Phibro, a unit of Occidental Petroleum (OXY.N) since 2009. He is well-known as an oil bull who often takes large directional bets on the price.

Note: Italics copied in verbatim

About the author:

Graduated with BA Economics from National University of Singapore. Passed Level 1 of the CFA examination and CAIA Level I Candidate. Long-biased US equities, with strong focus on small to mid-cap stocks (NYSE, NASDAQ, AMEX, OTC & ADR) utilizing fundamental and technical analysis.

Agnostic investor, trader, writer and perpetual student of the market.

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