Hedge Magazine, 2013. Original article (p30-33).
Robert Kosowski, director of the Centre for Hedge Fund Management and professor at Imperial College.
“History never repeats itself, but it rhymes.” Mark Twain said it first, but hedge fund researcher Robert Kosowski knows it’s true: “History is full of patterns that repeat, and unfortunately the financial services industry doesn’t necessarily learn. Things get given new labels. But if you look at the various crises, going back to the 1930s, there are a lot of similarities to the current crisis.”
This is partially what Dr Robert Kosowski, Associate Professor of Finance at London’s Imperial College, wants to teach his students. He has two mugs from Lehman Brothers in his office, left by an old colleague: “They always make me laugh. It’s an interesting reminder of the historical context. I intend to keep them.” We meet in an airy, modern lobby of the Business School, where Kosowski has an office across the street. As director of both the Centre for Hedge Fund Research and the Risk Management Laboratory, both students and industry professionals look to Kosowski and his research for insights into the cutting edge of hedge funds. But who has the best questions – the students or the fund managers?
“I think it’s a mixture of the two. There’s a lot of synergy between the academic work and the practitioner work,” says Kosowski, in his analytical, somewhat reserved manner. “Ultimately we try to educate students so they are prepared for the real world. We also want to produce research that’s high quality but also practically relevant. It’s absolutely fundamental to get feedback from executive education buyers, and from students and consulting clients.”
Real life academia
Kosowski’s research into trend-following funds and momentum strategies is a good example: this is not only academically interesting as it relates to return-predictability, but it can also deliver practical strategies for investors. While clients often want to hear about the latest academic insights into portfolio construction and return-generation, the key questions Kosowski faces are as you’d probably guess: how to recognise which hedge funds will do well in the future, how to distinguish good from bad funds, how to construct a sound portfolio, and so on. But if hedge funds remain an emerging field, how predictable can these factors really be?
“One of the strong predictors is fund flows. People tend to rush into things, and then those things eventually become overpriced. The more informed people enter first, then the less informed rush in later. That’s human psychology and that’s not going to change,” says Kosowski. But, he stresses, the reasons why alternative strategies generate returns can be traced back to both behavioural and rational explanations. “Rational explanations mean, if I ask you to hold a certain risk, you ask for a premium. Behavioural explanations may mean that there are genuinely some opportunities where there’s no compensation for risk.” Sometimes investors may find themselves on a winning streak without being able to fully understand why, which sounds like it should be frustrating for a researcher. But Kosowski doesn’t seem overly concerned about the anomalies: if a fund manager hits on a pattern that creates results, why shouldn’t he or she exploit it? “Now what we try to do, of course, is to rigorously analyse why something works. Because if we don’t have an understanding why it works it may just be statistical fluke, it may be temporary, it may just stop working. And there’s a very large amount of examples of that happening.”
Kosowski has published research demonstrating that the hedge fund industry delivers annual alpha returns of just over 4 percentage points, while only 1.32 percentage points worth of returns are down to beta – proof that the industry at large generates “statistically significant performance over long time periods”. But he’s not so willing to go along with the idea that the hedge industry has a PR problem. The last few years have been more challenging for the industry, he concedes, before pointing out that this happens to all asset classes so it’s nothing special for hedge funds. “Picking out one or two years to say that there are questions to be asked about the industry – I think it’s just spikes. But the same goes for picking out the best years and saying things will continue forever at the highest levels. I think this mean reversion is normal, and what’s important is to look at long time periods.”
Kosowski first started his research activities looking at mutual funds, but found this to be “intellectually restrictive” due to the regulatory restrictions. “And when you look at the whole universe of alternative strategies, it’s so much richer, much more interesting. It seems there’s a convergence of the traditional and the alternatives on this tree. I think the alternatives industry is becoming increasingly relevant, and there are still a lot of interesting questions to study,” says Kosowski, pointing out how the latest innovations are often considered alternative until they become traditional. “So it’s intellectually very interesting to work on that intersection, at the cutting edge of research.”
Current projects include research into trend and momentum funds, alongside Nick Baltas, and the related issues of capacity constraints. Another research topic is how to correctly measure alpha, and how this relates to leverage; “We’ve pioneered a new method to distinguish true skill from luck, and this has generated quite a bit of interest.” So are luck and intuition dirty words in the world of research? “Experience is certainly helpful, and intuition means you probably apply the thought process that you’ve gone through many times, just more quickly and almost subconsciously.” Kosowski thinks about it for a moment. “It all goes back to understanding what drives the returns. If we can’t trace it back to experience, if we can’t trace it back to a model or to superior information, then it may not be real.”
Doctor, swimmer, skipper?
Outside of work, Kosowski is drawn to the water, having initially excused invisible goggle marks on his forehead following his morning swim. While work keeps him very busy, the international nature of the research community means he does a fair bit of travel, having visited Australia last year and New Zealand high on the wish list. “I really like sailing and wind surfing, and I hope to get a skipper license this year. Last year I had a chance to take a sailing lesson in Airlie Beach near the stunning Whitsunday Islands. At one stage I was concentrating on the sails, when my sailing instructor pointed at the water and asked whether I had seen the dudong. I’d never heard of a dudong. It turns out it’s a large marine mammal, similar to the manatees found in Florida, and one has to watch out for them since they move so slowly.”
While Kosowski confirms that yes, he does get asked this a lot, I can’t help but want to know: why is he not a hedge fund manager? “It’s a fair question. My colleagues and I do apply our research through advisory work, some which may also be for firms that manage assets. The synergy between research and consulting is most interesting.” So it’s not because he doesn’t think he’d be any good? Kosowski laughs, before delivering the understated answer: “Since I get asked repeatedly to do consulting work which clearly is used in investment management, I guess I must be somewhat good at doing that work. But I like doing other things too. So my main position is at Imperial College.”