Cliff Asness’ Hedge Funds 101 | Chief Investment Officer

Cliff Asness, AQRAQR Co-Founder Cliff Asness wants you to know he understands hedge funds.

In a blog post, the outspoken quant manager clarified he isn’t confusing correlation with beta—he knows “they are not the same.”

“Beta measures how much, on average, a fund responds to stock market moves,” Asness wrote, “Correlation measures how ‘tight’ the response is.”

For readers who may not be clear on the difference, Asness explained hedge funds are generally net long about 40% of the stock market, leaving them a beta of 0.4. The rest is where hedge funds “attempt to do ‘other things,’” he continued.

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Typically these “other things” consist of taking long and short positions that should have “no direct market exposure,” Asness wrote, resulting in the same beta of 0.4. The fund’s correlation to stocks, however, would likely change.

“Ideally, in my view, hedge funds should just do the other things and have no market exposure—a 0.0 beta—but whether at 0.0 or 0.4 beta they will look relatively worse than the stock market during big bull runs,” he said.

And it is precisely these “other things” that deliver alpha for which investors should pay fees.

However, hedge funds have been hedging less recently, Asness wrote, which have reduced both attempted and realized alpha. This phenomenon also causes correlations—but not beta—to rise, making hedge funds’ value proposition “probably worse now,” he said.

In a separate blog post, Asness again defended a position he took last year—that annual lists of top-earning hedge fund managers are “simply bad, and intentionally misleading, math.”

“Article marveling at the 2015 compensation of the top 25 hedge fund managers are about wealth when they purport to be about income,” he wrote. “This ‘mistake’ likely occurs as higher numbers sell more papers than do lower numbers… This is not about the inequality debate; rather, it’s just about exaggeration and imprecision.”

Stock market analysts could be missing out on a valuable source of information on company fundamentals: Twitter.

Consumer tweets about company brands and products can carry “predictive power” regarding future sales and earnings results, according to a study by Vicki Wei Tang, associate professor at Georgetown University’s McDonough School of Business.

“Even though Twitter provides nonfinancial information that is informative about upcoming sales and such information is easily accessible… analysts do not fully incorporate in their forecasts the implications for upcoming sales of the collective wisdom of users of Twitter,” Tang wrote.

For the study, Tang enlisted the services of social media firm Likefolio to analyze third-party tweets made about 171 consumer-facing companies from 2013 through the end of 2015. The sample included only tweets about company products and brands, excluding tweets directly about the firms, in order to capture customer satisfaction and not investor sentiment.

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Tang categorized tweets by tone—positive, negative, or neutral—as well as by whether they indicated user intent to purchase a product.

She found that not only were these tweets predictive of upcoming sales—with predictive power highest when Twitter was the primary source of public information about a product—they went largely ignored by analysts.

Analyst forecast error was negatively correlated with the number of positive tweets and the number of tweets containing purchase intent, meaning that the larger the number of tweets, the lower the analyst’s forecast relative to actual sales.

“Analysts consistently overweight the financial information in prior years but underweight the nonfinancial information on Twitter in forming their forecasts,” Tang wrote.

By incorporating nonfinancial information published on Twitter into stock market analysis, Tang argued that investors can form more accurate opinions about individual stocks, and therefore make better investments.

“The valence and volume of tweets, once summarized, provide useful information in predicting firm fundamentals,” she concluded.