Manager vows to beat hedge fund returns for less

Date: Tuesday, June 10, 2008
Author: Svea Herbst-Bayliss, Reuters

Jerome Abernathy has a proposition for the world's biggest pension funds -- better returns than hedge funds without the headaches or heavy costs.

This may sound too good to be true to institutional investors, who have poured billions of dollars into the loosely regulated $2 trillion hedge fund industry in the hope of earning better returns, even as they worry about poor performance and the possibility a fund will fail.

But Abernathy, a money manager armed with electrical engineering and computer science degrees, is quietly convincing skeptics with proof that his Alternative Beta Fund delivers exactly that by investing in indexes instead of managers.

Sometimes called a "synthetic" hedge fund product or a "hedge fund replicator" -- a phrase Abernathy said he dislikes because it sounds pejorative -- the $250 million fund ended its first 12 months of trading in April with a 3.18 percent return after fees. That trumps the average hedge fund's 1.78 percent return during the same period, Hedge Fund Research data show.

"When we first began showing this product, people had a reaction of 'ah ha, well thanks for stopping by," Abernathy said in an interview.

Now they are more receptive.

"The 'ah has' are changing to 'Mmms'," Abernathy added with a laugh.

Abernathy, whose PhD from the Massachusetts Institute of Technology let him join a small circle of quantitative traders at Morgan Stanley before he moved to hedge fund Moore Capital in the early 1990s, spent years calculating the programs at his own firm, Stonebrook Capital. He calls it a "simple strategy that was complex to design."

Arguing that most hedge fund managers deliver most of their returns by bearing market risks instead of generating alpha, a measure of risk-adjusted performance, Abernathy said investors can do better with him.

He will, for example, let computers bet the Russell 3000 index will rise against the Standard & Poor's 500 index. The mostly passive strategy is reevaluated once a month and for this Abernathy charges 1 percent in fees. Hedge fund managers usually take a 2 percent management fee plus a 20 percent performance fee.

And unlike hedge funds of funds, who charge additional fees to help spread the risk by selecting a pool of individual hedge fund managers, Abernathy does not bet on other people.

At work and at play, Abernathy, 48, a sailor, pilot and diver, said he has experience with "all things fluid dynamics and activities where you have to control risk."

Funds can and will fail he warned, ticking off collapsed firms Peloton Partners, Sowood Capital and Amaranth Advisors.

So his way, he argues, will find supporters.

Already banks such as Goldman Sachs and other Wall Street firms that lend to hedge funds -- all huge rivals of Abernathy's New York-based Stonebrook Capital -- have similar programs.

But because these giants earn much more from selling hedge funds of funds products to clients and servicing hedge funds themselves, they are leaving the alternative beta strategies alone -- for now, analysts said.

While Abernathy's one-year track record is still a little short for many big investors to jump in, Abernathy's 7 person shop is fielding more calls these days because the system -- for which a patent is pending -- performed during one of Wall Street's worst financial crises.

"Our first 12 months weren't just any 12 months. They were THE 12 months," when the credit crisis battered Wall Street firms and hedge funds alike, Abernathy said.

By the end of next year, Abernathy hopes to manage $1 billion and within the next decade he sees room for that to grow more than ten-fold. While alternative beta strategies now manage only about $20 billion, analysts expect the amount to be near $100 billion in the next five to 10 years.

"Even if we only get 5 percent of that, that is an incredible growth opportunity," Abernathy added.