SAN FRANCISCO (MarketWatch) -- Merrill Lynch & Co. managing director Heiko Ebens had an awkward message for hedge fund managers and investors attending the 2007 MARHedge conference in San Francisco on Tuesday.
"Alpha has essentially disappeared" from the hedge fund industry, said Ebens, who heads equity derivatives strategy for Merrill in the U.S.
Alpha is industry parlance for the extra return, above what's offered by the market, that's generated by the skill of the hedge fund manager.
Ebens argued on Tuesday, in front of a stonily silent audience, that most hedge fund returns come from the broader markets and can be replicated by indexes constructed, coincidentally, by Merrill (MER
One of those so-called synthetic hedge fund products - the Merrill Lynch Factor Index - outperformed widely followed investable hedge fund indexes run by Hedge Fund Research, Morgan Stanley Capital International, Credit Suisse and Tremont, over the past three years, he noted.
Ebens touched on a sensitive subject for the hedge fund industry. As assets have ballooned and more managers have entered the business, some argue that increased competition for a finite number of trading opportunities has dented returns. If that's true, the high fees levied by hedge fund managers may no longer be worth paying.
"Costs need to be justified and with active managers, there's large overhead," Ebens said. "We don't have a superstar manager who we have to pay millions of dollars a year to keep."
Investors using Merrill's Factor Index are charged roughly 50 to 100 basis points a year. Another index, which replicates a hedge fund strategy called volatility arbitrage, charges similar fees, he noted. In contrast, hedge funds usually charge a 2% annual management fee (200 basis points) and take 20% of any profit each year.
Rather than being hostile to this synthetic, low-fee approach, Ebens said a lot of hedge funds have shown interest in using the Merrill products themselves.
By letting Merrill to take care of the returns that are generated by the market, hedge fund managers can in theory focus on trying to generate gains above and beyond that - the apparently elusive 'alpha,' he explained.
Hedge fund managers have been particularly interested in Merrill synthetic products that replicate short selling - a technique used in the industry to bet against stocks and other securities, Ebens said. 
Alistair Barr is a reporter for MarketWatch in San Francisco. http://www.marketwatch.com/news/story/no-alpha-merrill-director-tells/story.aspx?guid=%7b581F2096-F2FE-40D7-A3BC-E507FD07AD5B%7d&print=true&dist=printBottom
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