October 22, 2007 | last updated May 26, 2012 2:26 am
THEORETICAL PROFITS

Economic Academics | Hedge funds, remote to many, lure business school professors

The growing and lightly regulated hedge fund industry is attracting new players -- business school professors eager to test their theories in a field known for big risks and occasionally bigger rewards.

Hedge funds are becoming a tempting tool for faculty members looking to sharpen research and giving a Wall Street perspective to their students, all while making some extra money.

"MBAs and, to a less extent, Ph.D.'s have taken over the financial world," said Roger Ibbotson, a professor at the Yale University School of Management and co-founder of a hedge fund. "What we study is what people in finance know and use."

Hedge funds are a $1.1 trillion industry, largely unregulated and traditionally used by institutions and wealthy investors. Hedge funds profit by using unconventional techniques, such as short-selling, or betting on falling markets to make a profit during market downturns. They typically are active traders and can use techniques off limits to mutual funds.

While hedge funds frequently outperform more traditional investments, some have failed spectacularly. Last year, Connecticut-based Amaranth Advisors wrongly guessed that tropical storms in the Gulf of Mexico would cause natural gas prices to spike. The storms didn't develop and Amarath lost billions within a week, prompting lawsuits and congressional hearings.

Model Of Organization

Economic consultant Peter Bernstein said the link between academic theory and Wall Street is not new, but the interest among professors to run a hedge fund is.

"Wall Street does not know very much about theory," Bernstein said. "The whole notion of risk is something people didn't think about in a systematic sense. Academics come with a structure about how to compose a portfolio."

Ibbotson and Yale finance professor Zhiwu Chen founded Zebra Capital Management in 2001. Housed in an out-of-the-way office park in nearby Milford and staffed by analysts and computer technicians, Zebra has grown into a $265 million fund by using mathematical and economic models to develop investment strategy.

Its 18.2 percent return for the year through July outpaced the Standard & Poor's 500 Index, which gained about 3.5 percent in the same period.

Links between university research and hedge funds are good for both, said William Goetzmann, a Yale business professor who is Ibbotson's research partner.

Hedge funds are part of a "new frontier of finance," boosting universities that draw students who are interested in the industry, he said.

"It helps a school attract the best and the brightest of students," Goetzmann said.

Bernstein said many professors are drawn to hedge funds by the lure of money and little regulation.

"A lot more in fees, and a lot less constrained," he said.

Thomas Schneeweis, finance professor at the University of Massachusetts at Amherst and director of the Center for International Securities and Derivatives Markets, said professors and hedge funds are a good mix.

Recipe For Success

"I don't see how you cannot do both," he said. "For the most part, bonds and stocks remain something they're familiar with every day."

Schneeweis and Richard Spurgin, an associate professor of finance at Clark University in Worcester, Mass., are consultants at Lyra Capital LLC.

"It's a pretty applied field," Spurgin said. "We want students not only to know theory, but what's going on in the world, how theories are applied and bring some real world experience we have into the classroom."

Schneeweis said faculty members use their hedge fund activities to sharpen business school curriculum that he said seldom includes courses on alternative investments such as hedge funds.

"Initial textbooks do not cover those areas. Data are not available and faculty don't have a familiarity with it," he said.

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