| PAAMCO CEO Jane Buchan |
PAAMCO CEO Jane Buchan is a big believer in alpha — excess return over the market (beta). “Our clients are gorillas,” says the Irvine, California–based fund-of-hedge-funds firm co-founder, whose team advises some 90 large institutions, including MassPRIM and the North Carolina Retirement Systems. “They’re very big plans, so they pay very little for beta. We don’t think anybody should pay for beta.”
The 51-year-old Buchan, who has a Ph.D. in business economics from Harvard University and taught finance at Dartmouth College’s Tuck School of Business, started PAAMCO in 2000 with Jim Berens, Bill Knight and Judy Posnikoff. One of the first fund-of-funds firms to offer separately managed accounts instead of commingled funds, PAAMCO now has 135 employees in Irvine, London and Singapore and advises on $18 billion in assets. Buchan recently spoke with Alpha about how the hedge fund industry has changed during her time at PAAMCO.
Q. What’s changed the most about hedge fund investing?
A. Two things, I think, have really changed. For institutions, hedge funds are now a very core part of investment portfolios. I think if you were in the year 2000, particularly before the tech crash, people would be shocked by that.
And then on our front — and I think we’ve even helped some of the changes — people are really looking at hedge funds no longer as funds. Instead, they’re looking at the managers as being pure alpha plays, or sometimes alpha and beta plays. And the way they invest in hedge funds has become very institutionalized.
Q. Is there still alpha out there?
A. Well, hedge funds have produced a certain amount of alpha. If you look at the hedge fund index and you do a correct regression — so you take out the beta, you correctly adjust — the hedge fund universe as a whole has generated alpha on the order of 1.5 percent a year if you do a good job selecting managers. For us it’s several percent.
What’s interesting is, how can you have long-only active managers who are having trouble, but the hedge funds are still adding alpha? I think what’s happened is that the hedge funds have come in and captured the alpha that traditionally used to happen in active long-only equity.
Q. On the traditional side of the business, almost all new money is going into passive strategies.
A. Right, exactly. And my point is the alpha’s been moved from the active long to the hedge fund industry. I think what’s happened is these hedge funds, frankly, are more nimble. They’re more aggressive. Not necessarily in exposure, but they’re more aggressive or more active in terms of managing positions. They trade more. They do other things. There’s only a finite amount of alpha out there, and they’ve basically taken the alpha from long-only managers.
Q. How did that happen?
A. Active management’s had a really hard time. If you want to look for a villain of traditional long-oriented asset management, it’s the hedge funds. They come from a culture that’s results-oriented rather than process-driven, and they’re highly incented because of the performance fee to produce alpha. So what’s happening is, I think, they’re basically eating the long-only managers’ lunches.
I would predict going forward you’ll see big growth in indexing or other very low-cost alternative beta-type products. And then you’ll see growth in hedge funds and other active management strategies.
Q. The numbers certainly would seem to support that, as the hedge fund industry continues to grow.
A. Absolutely. And the problem is that when you look at hedge fund investing as an alpha engine, you’re not going to see big numbers. You don’t really see hedge funds, the big ones, now printing huge numbers, because they’ve all become much more alpha generators.
And the clients — whether they’re us as a fund of funds or whether it’s an end user — are all getting much more sophisticated and saying, “What are the risks you took to generate that return?”
