Facetious my title certainly is. Truth is, however, that with tools that exist today, and in the ever-expanding ETF world, any investor can be their own hedge fund.  [Interesting side note: News out recently has shown that regulation on the hedge fund industry may not be tightening at first thought: See “SEC Hedge Fund Registration Rule Struck Down by Court” from Bloomberg News.]

There have been numerous hedge fund debacles globally, leaving many investors, some of which should have never been in anything close to these instruments, completely devastated. A few serious ones have created big news up here in Canada over the past year. Despite this, hedge funds are proliferating like flowers (I was going to say weeds but it would be unfair to generalize). With recent evidence of no increased regulation on hedge funds, which I broadly define as mutual funds with fewer constraints, should we be getting worried?

Naaahhh, let’s all get out there and make tons of money! Seriously, we’ve all heard stories of ordinary people quitting their day jobs to become day traders back in the last 90’s. A similar migration has occurred in the past five years or so where traditional money managers have moved to start up or join hedge funds.

Why not? More freedom from reduced investment constraints. And the performance fees don’t hurt. Hey, I started in this industry managing directional strategies on equity index futures as well as long-short US equity programs. I’m not going to just flatly trash hedge funds. However, as I’ve said in an earlier entry, there is a clear problem in hedge funds that isn’t actually that new. Similar to many mutual funds that have been and are criticized for charging relatively high fees for what is essentially “closet indexing”, we now see hedge funds also providing more “beta” and less “alpha” than what was promised in their marketing material.

Unlike my previous “weed versus flower” comment earlier, I feel justified to generalize here: far too many mutual funds behave like indices. My fear: the same problem develops in hedge funds.

Many hedge funds state that they aspire to perform well in both good and bad markets. In other words, their performance should be independent to what’s going on in the market. The technical term is being “beta neutral”. The problem is that recent returns have shown that this may not be generally true. In fact, I observe that more and more, hedge funds as a whole have behaved more like “closet indexers”. I don’t think this problem existed prior to around 2003.

Here’s a recent story related to this problem from Sweden, but hedge fund industry watchers are noting this disturbing trend in other areas of the globe. (Note: registration to this site may be required but is worth it if you are interested in getting free news related to the hedge fund industry).

If you don’t want to sign up and are willing to do some research, dig up some of the data available on hedge fund indices and see how they compare to the broad market indices. Long term they differ, but in the past year or so, you see the strong similarities.

Although generally I’ve seen that a lot of broad hedge fund indices (not sub-indices specific to a certain strategy like “long-short equity” or “convertible arbitrage”) have beaten the broad market indices (S&P 500, MSCI World Equity Index, Lehman Aggregate Bond Index) by anywhere from around 1% to 5% in the first five months of 2006, the trend of returns during the strong up movement in the first four months and strong down movement in May provides compelling evidence that hedge funds are following the indices.

I can only surmise that after roughly three years of poor returns, in what has basically been a straight line up in the equity markets, hedge funds have had no choice but to expose themselves to beta while alpha has been (perhaps temporarily due to low VIX or countless other reasons) hard to find. I hope this trend does not continue. Perhaps we will enter a new market environment that is more akin to earlier periods when hedge fund strategies were more viable. As with mutual funds, perhaps there are also simply too many hedge funds. The market (investors) will have to let their money do the walking. With limited alpha, many hedge funds will simply have to die.

* * *

Let me now shift gears and bring us back to the ETF world of today, and what is clearly a significantly different place than where we were just one year ago. We now have many more ways to play the domestic and international equity markets through the recent explosion in non-market cap weighted ETFs (quite a lot written about this in the past few weeks!). In a previous entry, I’ve stated how I think these are not that innovative since the research behind them is quite similar to what Dimensional Fund Advisors have spoken about for decades.

What I find more significant and interesting is the introduction of the new inverse ETFs from ProShares (PSQ, SH, DOG, MYY) … for those of you who know ProFunds, Rydex and the like, these are the ultimate “Futures for Dummies” tool. With these new ETFs, and I can only expect that Rydex will be following up with their own version, the ordinary investor can treat a part of their portfolio in a “hedge fund” like manner. Hey, it’s just leverage. And shorting. Or a combination of both. Hey, should we be getting worried?

Well no. Earlier I stated my worries for a hedge fund industry that has had numerous blow-ups and has too many participants striving to find this thing called alpha. The problem, just like when we bash mutual funds for underperforming some benchmark, is the effect of management fees (along with other costs within a fund like legal, audit, custody and other administrative expenses) on returns. For the do-it-yourself investor, these do not apply. So why can’t the DIY investor have the same tools as the pros? I can’t really think of a good reason. Institutions for decades have had the ability to program trade so that they could adjust a portfolio with just a few keystrokes. We don’t really think of it now, but selling QQQ and buying SPY basically does the same. So what should we expect now?

I think that investors should be able to play the emerging markets, commodities and other asset classes both ways (long/short). There’s nothing stopping them now from shorting EEM or DBC. But for the many investors who do not feel comfortable with the concept of a margin (leveraged) account, this is a good first step. I also wonder if particular investors, including certain institutions with constraints that do not allow them to hold short positions or use derivatives, will see this as an opportunity to make tactical decisions within their portfolio.

Bottom line: Through ETFs, investors have many means to have various broad market exposures. With short (and levered) ETFs, they can also allow certain parts of their portfolio to become “hedge fund-like”. But perhaps it doesn’t have to go to that extreme.

As Roger Nasbaum has recently suggested when discussing these ETFs, perhaps only as a short-term play and with relatively small proportional holdings within the total portfolio, these tools are enough of a hedging tool to add to the overall strategy menu. I would only add that for most investors, the use of this kind of tactical defensive strategy does not have to be used often: major market downturns should be the focus, not the common oscillations that are a common component of short-term market action.

Against what Wall Street, and in particular the self-direct brokerages will tell you, trading frequency is inversely proportional to a portfolio’s overall performance. I just don’t want to have a repeat of seven or eight years ago except it’s now: “Yeah, I’ve dumped that dead-end job. I’m now running my own money as a hedge fund.” Please.

There’s been alot of recent news about new offerings being introduced by WisdomTree and Powershares and some not so recently by the bigger shops. I have two comments:

1. Market cap weighted indices. Rob Arnott is often credited with the introduction of an alternative to market cap weighted indices – specifically, the idea of an equal weighted cap index. The data looked conclusive and made a lot of common sense. In many ways, the basic idea overlapped well with the Fama-French 3-factor model which considers size (small versus large stocks) and value (high book-to-market ratios versus low BTM ratios) in addition to just market risk [CAPM]. So when the Rydex S&P Equal Weighted ETF (RSP) came out in 2003, which in highsight was a perfect long-term entry point after the bear market of 2000-2002, it looked like a good core holding for US equity exposure.Thereafter, Arnott’s writing moved into the area of fundamental weighted indexing and with it, a combination of various fundamental measures which could determine the composition of an index in a slightly more complex manner. More recently, Arnott’s firm Research Affiliates has worked with various manufacturers to introduce the next stage of non-market cap weighted ETFs, specifically PowerShares FTSE™ RAFI US 1000 Portfolio (PRF) as well as ClaymorETFs FTSE™ RAFI Canadian Index Fund (CRQ on the TSX), both based on his concepts of fundamental indexing. However, just like any other method of building an “index”, fundamental indexing will perform better than other manners of indexing in certain, but not all, markets.

WisdomTree’s new ETFs tread fairly closely to these also using the term “fundamental weighted indexing” in their marketing material (.pdf). I give true credit for a practical alternative to market cap weighted indices to Dimensional Fund Advisors. I find it interesting that DFA, the real pioneers of “thinking outside the box” in the world of index investing and whose funds revolve around the Fama-French 3-factor model, have not entered the ETF space. Their US-domiciled funds have a much longer-term track record compared to most ETFs, and have a loyal, almost “cult-like” following which is now growing internationally into the UK, Australia, Canada and other jurisdictions.

However, the way in which they market their funds through selective advisors does not lend well to a transition into ETFs. Furthermore, with the recent entry of WisdomTree, there may not be enough space in such a specific ETF market, but there still are some differences between the philosophies and methodologies at the two firms.

To me, the simplicity of RSP (equal weighted indexing) is magnified compared to the newer offerings of recent weeks or even the 3-factor model+. Costs seem comparable, but what we are seeing here is the move towards something that looks less like a traditional index instrument and more like a quasi-active fund. Powershares seems to be pushing the envelope the most as WisdomTree’s offerings lean more towards a simple dividend oriented bias.

Will someone try to build a fund that tracks an index whose underlying constituents are actively managed, such as a hedge fund index? Whether the logistics works out or not, I’d rather not see that happen. I can only imagine the spread between the market price versus the underlying fund’s NAV in addition to the numerous other potential complexities. Overall, it certainly is interesting what’s happening and I’m always eager to see what new innovation in coming down the pipe.

2. Although I am happy to see innovation in the ETF space as explained above with alternatives to market cap weighted indices, I am not so happy with what is broadly coined as “alternative investments”. Obviously, we’ve seen new products brought forth in conjunction with the commodities boom of the past few years, and especially very recently (GLD), (SLV), (USO), (DBC).

My concern with these is similar to the countless Nasdaq linked index products which came out just prior to the top in 2000. The idea of investing in materials and energy makes sense as components in a broadly diversified global portfolio. I just can’t see them being major (> 10% in each) holdings in this kind of portfolio.

Speaking of this type of portfolio, what would be a good model to follow? I like to see what certain large institutions are doing. Up here in Canada, we have a few pension behemoths that are quite innovative. In the US, there are far more interesting ones to choose from, but I’ll focus on endowments such as those at Yale and Harvard.

Without going to deep into details, I propose a read of Yale’s latest annual report (.pdf). A key excerpt that shows how different they think in terms of asset allocation:

Today, target allocations call for less than 20 percent in domestic marketable securities, while the diversifying assets of foreign equity, private equity, absolute return strategies, and real estate dominate the Endowment, representing more than 80 percent of the target portfolio.

Furthermore, they state that:

The Endowment’s long time horizon is well suited to exploiting illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.

Clearly, there are challenges to building an ETF, or other highly liquid instrument, for certain of these asset classes. So far, for investors interested in building a portfolio more aligned to institutions such as Yale, the energy complex and real estate are areas where they have been able to participate.

For real estate, REIT ETFs (RWR), (IYR), (ICF) are a start and Robert Shiller has been making the rounds promoting housing futures that began trading on the CME in late April. So, for the next stage of the growing ETF universe, what about an offering related to timber? Investment returns related (among other things) to the physiology of trees sounds like something that should be uncorrelated to the broad markets and may also provide decent yield. Another interesting area is infrastructure. So far, closed end funds (MIC), (MFD), (MGU) are the only viable choice for non-institutional investors.

Despite the interest from institutions in both these areas, I doubt there’s any significant interest from the ordinary investor that could lead to an ETF. But how many large cap value funds (whether domestic, international, or whatever) can you have out there?

A thought about correlations and what looks like the start of significant rebound. Here’s a look at some ETFs that have given up significant amounts but are up a good proportion relative to the drawdown since peaks of May:iShares MSCI Emerging Markets Indx (EEM): Peaked at 111.25 on May 8th. Bottom at 81.35 on June 13th, a drop of about 27%. It is now around 88.88, up around 9.25% from the bottom. More importantly, the gains from only yesterday and today have erased about a quarter of the one-month decline. We can dig into what technical indicators are showing but if you are a long-term investor with a long-term bullish fundamental view on emerging markets, this may be a good time to enter (or add to existing holdings).

A quick note on India which is not a significant part of EEM. According to a fact sheet on EEM on the iShares website, as of March 31st, 2006, only 5.3% of the fund was allocated to India. Here’s the chart for the India Fund (IFN):

Looks a lot like EEM so it’s very much the same story here. Even more massive decline, this time down 43.6%. Up a whopping 20% since its bottom on June 13th. Eyeballing this chart, it looks like again this very short rally has wiped out about a quarter of the total decline.

There is something happening here in the emerging market space. What about in the broader international equity ETFs? Here’s iShares MSCI EAFE Index Fund (EFA):

High of 70.65 on May 10th. Bottom of 59.40 on June 13th, a decline of -15.9%. Currently around 62.40, up about 5%. Again eyeballing the chart, it looks like roughly a quarter of the decline is gone.

For investors that have not sold during this decline and are trying to decide, this may be a time to wait and see if this rally continues. If I continue with a chart for the S&P 500, we see that the world markets really are highly correlated at times of extreme movement:

Another case of roughly a quarter of the declines erased (in this case a bit more).

We’re beginning to hear talk about this being a ’stock picker’s market’. I think this is a macro manager’s market. From the above charts, I argue that it’s more important to get the general market direction correct and securities selection is a far second in importance.

The question is whether to get in now with what looks like a good start to a serious market rebound. I could see some continued volatility but eventually I see a short term high in the equity markets, possibly even retesting highs of early May sometime near the end of this summer.

My focus however is not so much on potential upside in 2006 but more on the downside. Any rally that pushes us anywhere near or beyond the highs of May will force me to do what we did in April (buy puts, load up on cash) and maybe go further (greater amounts of cash/puts, buy VIX calls, heavier allocation to bonds versus stocks). I think this will be an important discussion for later this summer.

On the bond side, I can’t see the bond ETFs doing that well in the very short term with considerable debate now about rate hikes possibly well into the rest of the summer.

Regardless of the viewpoint (for next 3 months or 6 months or beyond), I strongly believe that considerable cash positions must have been built in the past few months not only for allocation to equities (now?) but also into bonds (possibly a few months from now?).

Synchronized markets mean that trading ETFs and derivatives will be an effective means for implementation.

A quick note for investors looking to get into gold stocks, since they’ve dropped about as much as anything else out there. With a lot of discussion regarding Market Vectors Gold Miners ETF (GDX), we in Canada have had a similar instrument in the Canadian Gold Sector Index Fund (XGD). It is also an ETF consisting of gold producers, but these are for those within the S&P/TSX gold subindex. For those considering GDX who wish to throw some longer term historical numbers into their spreadsheets to run some backtests, note that you can go to Yahoo Finance and punch in XGD.TO to get numbers back to March 2001. This may make better sense than using gold bullion prices for asset allocation historical simulations.

More info on this Canadian domiciled ETF can be found here.

Note that XGD only has 17 holdings and so with an MER of 0.55% it isn’t a great bargain within the ETF space. According to the Van Eck Global website, GDX has approximately 45 gold mining companies and is very similar in terms of cost.

iShares™ CDN Gold Sector Index Fund

Again, my point here is that XGD is your only tradable instrument for which you can obtain a roughly 5-year history to see how it would have affected your portfolio.

Also take note that XGD has a high correlation to GLD but is significantly more volatile. Point of fact: Peak price of XGD was on May 11th at 92.00. Opening price on Tuesday was 62.50. 32.1% drop but it brings us roughly back to where we were only 3 months ago as shown below!

I like the combination of a gold stock ETF, like GDX or XGD, along with a gold bullion ETF such as GLD or IAU. However, due to the relatively high volatility, for me this “gold combo” gets a smaller allocation of roughly 5-10% combined of the total portfolio. For a more tactical or global macro mandated fund, I’d still control maximum allocation to probably no more than a third based on a simple risk budget metric.

There are alot of energy based ETFs out there to select from, many of them covered well on Seeking Alpha’s ETF site. We have been holding all our energy related positions despite them being down roughly 12% from their peak in early May. Relatively high cash balances and some broad market put options have helped ease the pain. We still feel strongly about our long-term view on the commodity complex, especially energy, as well as certain other areas like emerging markets.For those that have built some cash, this is a follow up to my previous “shopping list” discussion but with a greater focus on energy. Now that we’re well into June, there will certainly be increasing talk of upcoming tropical storms and speculation of their potential growth to hurricane status. With ongoing events in Iraq and Iran, volatility in this area will certainly remain high which should be good for the numerous energy related funds I see popping up.

Below is a 1-year chart for five fairly broad energy related funds, although IGE tracks a broader natural resources index. I include it because according to the iShares website, it has a roughly 78% weight in oil/oil services plus 4% in gas. Not an insignificant divergence among these energy ETF choices, especially during the volatile period of the past three months.

Energy ETF 1-yr chart:

What interests me and what has been a great performer in our portfolios has been alternative energy, specifically the PowerShares WilderHill Clean Energy ETF (PBW). Taking the two “middle of the group” performers from the above chart and including PBW, we have the following 1-year chart:

PBW 1-yr chart:

I note two things from this second chart:

1. There is a fairly high correlation between all the funds which is of little surprise.

2. PBW’s relative outperformance of other broad energy ETFs.

With regard to the correlation, we can see from this chart that from early June 2005 to early January 2006, the lines overlap fairly well. The only sizeable divergence was during late August/early September (prime hurricane season).

But what about the sizeable divergence for most of 2006? The stocks shown above have similar up and down blips, but PBW seems to have become a “high beta” version of the energy plays. Proof is in the recent declines. PBW is down nearly 18% since its peak on May 9th. VDE and XLE’s declines are 13% and 12% respectively.

This really isn’t that surprising if you go to the PowerShares website and look at the holdings of PBW. The roughly 40 positions are certainly not all big names. Big sector weights in info tech (30%) and industrials (35%). Energy is shown as having only a 2.4% weighting. Average market cap of PBW is somewhere between that of PowerShares’ small and mid-cap ETFs. So the volatility is not that surprising.

Analysis of the 4 largest holdings (IMCO, QTWW, MGPI, ZOLT) as well as the largest positions thereafter show a general common uptrend from the beginning of the year. All of these positions have a story that is quite separate from the broad energy story. Thus, it might seem that during times of higher energy focus in the financial markets (like hurricane season), PBW behaves more like an energy fund as investors play the alternative angle. At other times, the fundamentals of its underlying holdings play a more distinctive and significant role.

If this hurricane season is anything even close to last year, you really have to wonder if alternative energy will be perceived as a place for significant asset allocation. I’m still not sold on alternative energy’s potential to replace traditional energy to keep the manufacturing process moving. I just can’t imagine how alternative energy could even come close to addressing global energy needs all if oil, coal and nuclear were suddenly wiped off the planet today. We’ve got a long way to go which is all the more reason to see the potential upside on something like PBW.

Finally, I was recently at an environmental finance conference sponsored by the University of Toronto. The main subject of the conference was actually “cleantech.” Interesting that there was a big absence of investors (institutional or retail) at the event. Through a contact from the event, I learned of a potential cleantech ETF. This was confirmed Wednesday of last week with the new of PowerShares’ SEC filing of 31 (wow!) new ETFs including the PowerShares Cleantech Portfolio ETF. Something to watch for.

Again, what we’re looking for here is something that can behave like an energy play during energy sensitive periods (with price action on the upside) and with potential greater upside during times of less dramatic energy sensitivity in the markets and general public persona.

Just remember that PBW is volatile. The current 18% drop is not the first time this has happened in PBW’s short 15 and a half month life. It had about the exact same percentage drop in its first two months (March/April 2005) and again in the fall of 2005 (basically after Katrina). Strong stomach required.

PBW 1-yr chart:

Whether you believe that the correction is nearly over, or that we’re about halfway through (or even more bearish than that), hopefully you have built some cash reserves and hopefully this was done prior to the May selloff. If so, it’s time to build a shopping list. Here are some positions to consider:1) First, a look at an area that has been hurt badly and is probably the best area for constructive debate: emerging markets. The iShares emerging market ETF (EEM) has gone from a high of about 111.25 to 89.80 (always using yesterday’s close), down about 19.1%. Vanguard Emerging Markets VIPERs (VWO) has gone from a high of about 76.51 to 61.63, down about 19.4%.

Coincidentally, according to the charts, we’re right back where we were at the beginning of 2006. Roughly 0% return YTD. Now, there’s been a lot of talk about potential slowing of trade in the EM region as a consequence to bearish views on the US economy and rightly so, but what percentage of future EM trade will be dependent on North America? Separately, looking at a long-term chart of EEM/VWO, you have to think that some steam had to be released from the pressure cooker.

Also important to note are the big holdings in EEM/VWO like Samsung Electronics. It is the largest holding in both of these ETFs with roughly 5% weighting in each. That’s actually not bad compared to Samsung’s roughly 20% weight in the South Korean ETF (EWY). South Korea is down just over 16% since its peak in early May and so it isn’t surprising that EEM/VWO are both down similar amounts considering that there are some large holdings from this one country (Of note, South Korea raised rates unexpectedly today which could further the bleeding … in fact South Korea was down 3.5% Thursday with the rest of east Asia performing similarly).

Of course, there are significant holdings in other EM regions like Latin America which have been even worse. The Latin America ETF (ILF) is down about 22.6% since its peak on May 10th. Again coincidentally, ILF is very close to where it was at the beginning of the year. The numbers may sound scary, but I think there’s plenty of room for prices to go down further. How far and for how long no one can know. I haven’t even commented on views regarding the BRIC countries and news of possible upcoming BRIC ETFs. But as a long-term investor, I think it would be prudent to at least have a 5-10% allocation to EM equities such as EEM or VWO. The trick will be avoiding major drawdowns like we’ve seen in the past month.

2. Bond ETFs. Inflation and the debate if there is or isn’t any, or if there will be or won’t be any in the near future has almost made my mind numb on the subject. It seems like it’s an unending debate on CNBC but luckily the World Cup will occupy a lot of my upcoming screen time. We’re still not fully in on our bond exposures (relatively overweight cash in lieu of bond ETFs). We’ve held certain index bond mutual funds and a few bond ETFs (including TIP) but are currently working on this area of the shopping list. I’d like to see a US domiciled international bond ETF. Let me know if there is one. For now, I’m watching TLT. I’ll update our progress on this area in a later entry.

3. Commodities. We’ve held all our commodity based ETFs during this market downturn as we have only about a 5% weight in materials (gold related ETFs) and energy (IGE, PBW). Of note to Canadian investors, we hold the TSX gold subindex ETF [XGD] and the TSX energy subindex ETF [XEG], both traded on the TSX.

We may rebalance these by topping up at some point but expect both gold and oil related ETFs do drive up sharply over the summer months. For those that have been tactically inclined and gotten out of these positions recently, I can only bet that you are contemplating new points of entry. But, like the EM positions from point #1, these are obviously volatile so from a risk budgeting framework, I would not consider putting more than 10-15% in the commodity complex.

We, up here in Canada, are not immune to the “home bias” phenomenon so have greater than global market cap weighted allocation to Canadian equities. Thus, since a broad Canadian ETF has nearly 50% allocation to materials/energy, an investor with a 10-15% allocation to the commodity complex plus a 20% allocation to Canadian equities may actually have close to a 25% commodity sensitive portfolio.

Thursday’s opening bell is about to go off. Despite some news from Iraq, the mood is not good at all after market action from Europe and Asia. A lot of uncertainty. Wouldn’t be surprised if VIX finally breaks above 20.

As mentioned in my previous (and first) entry, I actually started in the industry at a highly specialized hedge fund (separate managed futures and long-short equity mandates) although we never called ourselves a hedge fund. Now I am more focused on traditional long-only, no leverage, broad global asset allocation mandates.Weird, I know. Everyone else is dumping their mutual fund manager job to start up a hedge fund. Can’t blame them. Sure there’s the money. That’s a reward for being smart, good, lucky or some combination of this and more. However, the truth is that what any type-A personality in this industry wants is independence. What is a hedge fund but a mutual fund with lesser constraints?

Ask any manager what is more important: Being right or making money? I’m pretty sure they’ll say making money. But to make money, you better be right. As a mutual fund manager, you can be right but still perform poorly. In sharp down markets, without the ability to tactically allocate to cash or even short, it’s tough to protect the investor. Rather, it’s all about relative performance in that world, thus the argument that most mutual funds are “closet indexers”. For most readers, everything thus far is nothing new.

What concerns me is that we’ve just seen a very interesting month in May. Comments have been made that it’s the worst month for the S&P 500 in 22 years. To me, the price action of the S&P 500 is nothing like what’s happened earlier in Iceland, New Zealand and markets in the Gulf region. Can we expect more? Possibly, but my concern in particular is oriented towards the performance of active managers, specifically hedge funds. Big down returns in index funds especially for specific areas like emerging markets and commodities are fine. Hey, if you didn’t know these were volatile asset classes or that they had a nice long and fairly stable run up that past few years, welcome to class! But hedge funds should have made a killing this month. After at least two years of unspectacular returns (blame low VIX, low interest rates or whatever else you want) they must have been waiting for a month like this.

However, the word is out that hedge funds in general did not have a good month. I’ll wait to see what the various hedge fund index providers send out later in June for the May numbers, but this would be a great surprise to hedge fund investors. Or should it be? Hedge funds had very decent returns in the first quarter of 2006. VIX was still relatively low and there weren’t any big market events tossing things around. Basically, things were quite boring with decent broad market index returns.

Can we simply conclude that many hedge funds had substantial long positions in commodities, equities and other broad asset classes? That would be too simplistic an answer so I’ll ask it differently. After years of relatively poor returns, have many (or most) hedge funds exposed themselves to broad beta exposure due to the relative scarcity of alpha during the market run up from early 2003 to early 2006? The answer is yes.

Don’t get me wrong. I’m not anti hedge fund. But if hedge funds and “fund of funds” market themselves as “performers in good and bad markets” that implies market neutrality or specifically beta neutrality. There has been significant discussion, especially in the institutional world where costs for beta exposure matter, that hedge funds in general have had higher than expected beta exposures, and specifically to the S&P 500.

So, mutual fund managers said that they manage their funds well to outperform their target benchmark index but have in aggregate been more like index trackers. The question to ask is: Are hedge funds falling into the same trap?

My answer is no. I think that they’re doing what they have to do. Being right or making money? Well, I think they’ve realized that 2003-2006 was basically a desert for returns. Their quest for an oasis has led them to beta exposure. That’s part of being opportunistic. If their strategy (whatever it is whether some form of arbitrage or directional trading) has not worked as in the past due to the current market environment, what choice did they have? Again, they say that their job is to be “performers in good and bad markets” not just “performers in bad markets”.

The only question now is whether their beta or market exposures are so high that they their returns are highly correlated with market returns, especially on the down side. If this correction continues with hedge funds returns moving lock-step downwards, then there will have to be some serious rethinking of their value added by investors as well as some reflection by the hedge funds and “fund of funds” of their own philosophies and processes.

As this is my first posting on the SeekingAlpha blog network, I’d like to first thank David Jackson for the invitation to be a contributor. I’ve followed Seeking Alpha since its beginnings and have a lot of respect for those who provide the write-ups on a continuing and periodic basis. Hopefully, I can add some worthwhile input of value to readers.I’d like to give a bit of background on myself as a set-up for a variety of issues that I hope to get into greater detail in the near future. I started in the industry working in an investment firm whose primary business was tactically trading North American equity index futures. We’d be either 150% long, 100% short or cash.

The business expanded to include US equity long-short portfolios. In this case, we basically had to be fully invested so when we couldn’t fill in the gaps with stocks, we used ETFs (specifically SPY and QQQ). We were also briefly involved with principal protected notes with underlying fund-of-hedge funds. I learned most of what I know now of this industry during my six years at this firm.

After bouncing around for a few years thereafter, I co-founded the company I now run, Toronto-based Meridian Global Investors. Our focus is on broad global asset allocation (more strategic than tactical AA) with a strong bent towards alternative asset classes, although not necessarily hedge funds. Implementation for nearly all asset classes are through ETFs, derivatives, and certain passive oriented funds such as those provided by Dimensional Fund Advisors. However, we do have some stock and bond selection although in a very limited manner. Basically, if we can use an ETF or similar instrument, we would prefer that but we would never allow our investment process to be bound by rigid policies. We are primarily retail based now but are beginning the process to move business development efforts to the institutional side. Our process is highly risk measurement/management oriented to provide performance that best controls volatility.

So here’s what I hope to provide readers of Seeking Alpha:

· Thoughts on specific strategies using passive instruments.

· Thoughts on specific ETFs, closed end funds, index options and futures and index mutual funds

· Thoughts on the art and science of risk management, specifically what I believe to be the holy grail which a lot of institutions are trying to build for themselves – the risk budgeting system.

· Thoughts on the so called “new paradigm” in investment management which involves the separation of beta and alpha. The terms “portable alpha” and “alpha transport” (they’re synonymous) are viewed by some as a marketing ploy while many truly see this as the future of institutional money management. Will this new process improve problems with pension liabilities? Can (and should) the process be applied to the retail investor?

· Thoughts on the pension crisis and whether this new paradigm will offset: 1) the growing number of pensioners (who are dying later while often retiring earlier) and 2) the disproportionate ratio of paying working contributors to retired pensioners in most plans (numbers look bad, but the trends look worse).

· Thoughts on some of the more innovative institutional investors and the pros/cons of what they’re doing versus the more traditional institutions.

· As a mirror to the pension crisis, thoughts on retail investing and the battle between traditional actively managed mutual funds and ETFs/index mutual funds. Also of interest to me is the retailization of hedge funds especially through the use of structured products and specifically principal protected notes.

· Thoughts on broad global geopolitical and macroeconomic issues that we are looking at and how it has lead to specific position views.

There’s a lot of varied and interesting writing going on in Seeking Alpha, so I know that a lot of what interests me will have some broad overlap with other contributors. I only hope that my input creates some discussion (and even some debate which I think is healthy exercise for the brain of every investor). Lastly, I hope the readership finds a similar amount of interest to mine in these issues.

FYI: My firm is currently at a defensive stance. With an overweight position in cash for all of 2006 (allocation due to an underweight in bonds) plus put options on DJIA and TSX 60 (Canada) implemented near the end of April, we are about as defensive as we can be due to investment policy constraints. Broad equity index exposure is at roughly at its median weight but with higher exposure to international equities, especially east Asia/EM in lieu of low exposure to US equities. Alternatives are relatively high which includes commodities (fully in gold and energy as well as some alternative energy), infrastructure and some timber. We were right with the high cash, low bonds and put options but the equities (especially international/emerging markets) and alternatives have hurt us.