The Mystery of TIPS

Practitioners are accustomed to thinking of TIPS (Treasury Inflation Indexed Securities) as an alternative to conventional bonds, not an alternative to stocks. But TIPS are not much different from stocks: Both securities provide income that rises with inflation, or a fall in the relevant real cost of capital. So, TIPS should be viewed as "government stocks." Yet, TIPS have yielded as much as four times the stock yield. The only explanation for this mystery is that many in the investment community still consider TIPS (if they consider these securities at all) to be an alternative to conventional bonds rather than an alternative to stocks. TIPS yields and stock market yields (plus a 1 percent growth premium) are the best measures of the cost of capital for, respectively, the government and the corporate world. Because of the parallels in the ways the two assets deliver returns to their investors, a comparison of the two is today's best measure of the relative attractiveness of stocks and bonds. Hedge funds and other alternative investments are treated as a small and specialized part of the investment universe, but in fact, they are the broad part, representing just about every possible investment strategy outside the narrow set of “traditional” investments. Hedge funds encompass all investment strategies that allow both long and short positions and that allow leverage. They span all markets, from derivatives to emerging markets to real estate. And the focus of hedge funds is dynamic—waxing and waning as new markets and classes of financial instruments arise and other markets and securities become commoditized.Therefore, treating hedge funds as a category to study or monitor is all but impossible. I argue that, in fact, there is no such class as hedge funds. Hedge funds are not a homogenous class that can be analyzed in a consistent way. The “hedge funds/alternative investments” moniker is a description of what an investment fund is not rather than what it is. The universe of alternative investments is just that—the universe. It encompasses all possible investment vehicles and all possible investment strategies less the traditional investment funds and vehicles.This all-encompassing nature of hedge funds has important implications for the study of and attempts to classify hedge funds and is critical for the attempts to regulate and provide standardized risk management for hedge funds. To study hedge funds is to study the world of investment strategies. And with so broad a classification, seeking a uniform approach to regulating hedge funds or managing hedge fund risk is tantamount to setting up a standard for regulating the entire investment universe. It is like getting a committee together to develop a single set of traffic rules to apply to all modes of transportation from pedestrians to commercial jets. Faced with so general a task, what more can one say than “Be careful”? I believe that we will discover—as we continue our attempts to study, categorize, manage, and regulate hedge funds—either that we have failed or that we have enveloped the entire world of investments under a different name.