It could be the worst deal: 1.5% average up front and 20% on your profit.
Well, if they make you a lot of money, it is not too much to ask for. However, they risk your money by betting big recklessly. When they win, they get 20% of your profit and they use you for advertising to lure another suckers. When they lose YOUR money, they do not lose a penny. It encourages them to take big risk. I do not know any HF manager pay you back your loses.
You have better return buying SPY or other diversified ETF than an average hedge fund. For comparison, you need to add dividends, minus taxes and include those hedge funds which are out of business termed as survivor bias (and there are many and most likely due to losing big). To them, they just open another hedge fund and give you all the excuses of losing your hard-earned money. They may lose their reputation. However, memory will fad and most 'blown up' former HF managers just work for another HFs.
As of 2-2012, they do not beat SPY as a group.
Most hedge fund managers learn modern portfolio theories from Ivy League universities and apply them in the HFs. The theories are faulted.
Some use their specialty and that's fine. If they use derivatives, stay away and that's what happened to our financial crisis. If you still want to invest with them, ask their methods and historical performance. Very few HFs are good. They're the market, so it is impossible to beat the market as a group.
The owner of a famous base ball franchise lost big from his hedge fund concentrating in oil while every ETF in oil that year made good money. He stayed with the hedge fund. When they cheat you twice, shame on you.
One hedge fund has a performance of 25% every year for a long period. SEC, takes notes and investigate whether they're using insiders' info. There are few HFs giving good consistent performance beating the market. If you find some, stay with them. Otherwise, just buy SPY and have a good sleep every night instead of waiting for the black swan to wipe out your saving and/or frauds as this industry is not properly regulated.
Do not believe any papers praising how great the HFs are without knowing their credibility and their hidden agenda. Same for Hedge Fund indexes. Usually they ignore the survivor bias of the bankrupt HFs and those early exits that are many. In addition, most likely the comparing index like SP500 does not includes dividend. The short-term capital gain (better than loss though) would wipe out profits.
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(c) TonyP4 2012. Written in 2/19/12. Last updated in 5/9/12.
Disclaimer:
Do not gamble your money you cannot afford to lose. Past performance is a guideline and does not guarantee future performance.
All my posts are for informational purposes only. I'm not a professional investment counselor. Seek one before you make any investment decision.
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Loser: Long Term Capital.
ReplyDeleteKWM3 said:
ReplyDeleteThe fund that I know with the best performance is Renaissance Capital Mgmt's. and Bridgewater's offerings, they've left other funds (of any flavor or variety) in the dust since inception. Stick with them, they work.
Lott said:
ReplyDeleteWell, as a former hedge fund portfolio manager, its clear to me that there is a lot of misconception about the industry. Sure, given the asymmetrical risk reward nature of HF economics, there are a few who bet big so to speak, knowing that the upside is 20% of the profits, and the downside is that they lose nothing.
But this is a gross exaggeration. Most managers have significant portions of their own net worth in their own funds, and the downside if you lose big isn't zero as stated above. It is indeed your career on the line. Guys who "blow up" in HF lingo are out of work, simple truth, or you have to make up all your losses before you are paid again. Lots of guys blow up and end up not able to find jobs on the buyside again.
I haven't looked carefully at the data, but I would guess that up until 2005, HF's were pretty good at beating the market. After that, the asset sizes grew too large to see significant market out performance. I mean, if HF's are $2TT of assets in a $10TT market, and account for 1/3 of the trading, they are having to beat themselves. They have become too much of the market to outperform, and the information advantage (of better research and trading tactics), is of limited use now.
One person wrote that most hedge fund managers espouse MPT. Flat wrong. Most attempt to find an area of expertise, and stick with it. Funds are usually long short equity, distressed, commodity or macro focused, credit related, whatever. But in a decade in the industry, I never saw one MPTer out there, and really only saw Long Term Capital (and maybe Renaissance) resulting from a pile of Nobel laureates. (LTC wasnt about MPT by the way, Merton & Scholes figured out how to price derivatives and the fund was all about arbitraging various assets classes.)
I did see a lot of market timing, however, and chasing of hot stocks too. But mostly I saw highly intelligent people who worked very very hard, long intense hours in highly stressful conditions, with their own necks and net worth on the line trying to make the best returns possible. Perhaps there are too many HF assets out there to beat the market today, but trying nonetheless. And I should point out too, there are tons of HFs that do still outperform the markets, even after fees. But yes, it is getting much more difficult to do so.
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Will modify my blog accordingly.
Macro Economist said:
ReplyDeleteI have been investing in hedge funds on behalf of institutional clients for longer than I care to remember.
Once upon a time hedge fund managers could create alpha, but the influx of money into traditional strategies such as Long/Short Equity has diminished the amount of available alpha unit per manager. These days, Investors can find relatively more alpha in lesser crowded or "alternative" alternative strategies.
The AIMA report was nothing short of intellectual laziness and downright obfuscation and a classic case study on how selection and survivorship bias can make any lot of statistics prove one's point.
But with every ying, there is a yang. In benchmarking our firm's hedge fund investments, we have chosen the HFRI FOF index in order to minimize biases and reflect the immense costs required to properly diligence hedge funds. Even then, we suspect those numbers to be overstated by 100bp. That being said, using the net returns actually experienced by hedge fund investors, it turns out that hedge funds have under performed the KPMG figures by more than 4%. In fact, hedge funds have under performed a simple 60/40 allocation to MSCI World and Investment Grade bonds. This doesn't take into account short-term capital gain taxes, which make hedge funds an even worse choice for domestic US investors.
With the exception of a few savvy institutions such as Yale, the move into hedge funds by pension funds is a lesson in stupidity and is a classic example of what happens when you put politically savvy but unqualified professionals at the top, where the result of their actions will not be known for years to come.