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Hedge Funds
Old 02-04-2015, 09:52 AM   #1
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Hedge Funds

There was a thread recently (something about a derivative exchange) where I made a disparaging comment on being classified an "accredited investor" is nothing more than an invitation to attempt to scam you.

You need that distinction to invest in hedge funds which receive lots of hype. Many years ago I was solicited to buy into one and the sales pitch was based on now that I have achieved "accredited investor" status I could invest like the rich people do. So if I didn't invest in the hedge fund, I was being stupid. I never invested and never bothered to see how the fund did.

Warren made a bet with a hedge fund. Here's the link for anyone considering investing in a hedge fund.

Buffett's index fund outgains hedge funds in 10-year bet
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Old 02-04-2015, 10:34 AM   #2
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From the article:

Quote:
The Vanguard S&P 500 Admiral index fund Buffett chose is up 63.5 percent since the bet began.

The five funds of hedge funds Protege picked were up roughly 19.6 percent.
Wow, that's some serious under-performance.

I've often wondered about these hedge funds. Did a few of them really have 'gurus' that would rather work these small, elite hedge funds rather than something for the masses like Fidelity?

Or maybe some make the money not really from investing, but technical stuff like HFT where maybe they can skim tiny amounts from lots of trades?

Who knows if those hedge funds are representative, but I suspect there is no magic, mostly marketing to the elite.

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Old 02-04-2015, 11:09 AM   #3
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And a chart:



Not very impressive for the hedge funds.

Odd that chart starts mid 2007 - the bet was from Jan 2008 - maybe just the scaling is funny?

And you can see here (set the time bar to Jan 2008), Wellesley performed about the same as S&P overall, but with less volatility than either.

PerfCharts - StockCharts.com - Free Charts

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Old 02-04-2015, 11:24 AM   #4
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Originally Posted by ERD50 View Post

Who knows if those hedge funds are representative, but I suspect there is no magic, mostly marketing to the elite.
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Not very impressive for the hedge funds.
+1 on both counts. Hedge funds are more appropriately named "private investment funds", because hedging, which is an important part of prudent institutional financial management, does not require separate, private funds.

Unfortunately, the majority of money in hedge funds does not come from the elite, but folks with pensions. The biggest hedge fund investors are institutions, and the biggest (I think) institutional portion is pension funds.
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Old 02-04-2015, 01:19 PM   #5
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CNBC had a segment on this and I heard something from a mouth of an active fund manager I have never heard before....He actually admitted fund managers can't beat a low index fund over that time period. So you think that he was implying drop him and invest in index funds? Most definitely not. He immediately dismissed the whole notion solely on the thought that "nobody invests for a time horizon that long". Thus making it an irrelevant point as you need an active fund manager to guide you through the constant changes in investment priorities. I must be the fool then as I never sell my index mutual funds and just add to the same one. I guess I am not a sophisticated enough investor to have changing investment priorities.


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Old 02-04-2015, 01:42 PM   #6
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Quote:
Originally Posted by ERD50 View Post
From the article:



Wow, that's some serious under-performance.

I've often wondered about these hedge funds. Did a few of them really have 'gurus' that would rather work these small, elite hedge funds rather than something for the masses like Fidelity?

Or maybe some make the money not really from investing, but technical stuff like HFT where maybe they can skim tiny amounts from lots of trades?

Who knows if those hedge funds are representative, but I suspect there is no magic, mostly marketing to the elite.

-ERD50
It seems like every year I read about how hedge funds fell behind the prior year, messed up, bet on the wrong horse, etc. 2013 was a good example of a year where hedge funds way underperformed.

Yet every year there seem to be plenty of foundations, pensions, institutions and individuals investing in hedge funds. I never could understand it other than the "exclusive" sales pitch.
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Old 02-04-2015, 02:02 PM   #7
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Thanks for the heads up and the link.

Here's the Fortune story: Berkshire‚€™s Buffett adds to his lead in $1 million bet with hedge fund - Fortune
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Old 02-04-2015, 04:21 PM   #8
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I can accept the underperformance of hedge funds compared to the S&P 500 index. It always made sense to me that Buffett placed his bet on an asset class such as U.S. large caps that is expected to do well over a ten year time frame. What really bothers me is that the hedge funds are also underperforming a total bond index fund. BND or some similar investment would have returned around 35% from 1/1/08 through 12/31/14. That's close to double the total return of the hedge funds in the bet.

So hedge funds come across as a sure-fire path to sub par returns, either through the hedge fund managers making silly, ill-advised bets on underperforming asset classes, or from exorbitant fees, or from some combination of the two.

I suppose that with three years to go, it's highly premature to declare Buffett the winner. He could lose most or all of his lead in a single year of lousy stock market performance. But the hedge funds have performed badly enough for long enough to make any sensible investor question whether they can ever consistently justify their high fees.
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Old 02-04-2015, 04:28 PM   #9
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I can accept the underperformance of hedge funds compared to the S&P 500 index. It always made sense to me that Buffett placed his bet on an asset class such as U.S. large caps that are expected to do well over a ten year time frame. What really bothers me is that the hedge funds are also underperforming a total bond index fund. BND or some similar investment would have returned around 35% from 1/1/08 through 12/31/14. That's close to double the total return of the hedge funds in the bet.



So hedge funds come across as a sure-fire path to sub par returns, either through the hedge fund managers making silly, ill-advised bets on underperforming asset classes, or from exorbitant fees, or from some combination of the two.



I suppose that with three years to go, it's highly premature to declare Buffett the winner. He could lose most or all of his lead in a single year of lousy stock market performance. But the hedge funds have performed badly enough for long enough to make any sensible investor question whether they can ever consistently justify their high fees.

The CNBC segment on this mentioned something the article didn't mention I believe. The 1% plus annual expense fees are pounding the hedge fund compared to Buffets Total Stock Admiral fees of .05.


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Old 02-04-2015, 05:10 PM   #10
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I think it was Buffet who said Hedge Funds were a compensation scheme masquerading as an asset class.




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Old 02-05-2015, 11:38 AM   #11
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this guy seems to like Hedge funds:

Investing In A Hedge Fund Saved My Retirement Portfolio | Financial Samurai

"From 1990-2014, hedge funds (as measured by the HFRI Composite Index) have returned ~10.19% net of fees annualized returns compared to ~9.19% for the S&P 500 with half the volatility of 6.81%. $1 invested in the S&P 500 in 1990 would be $8 today. Meanwhile, $1 invested in hedge funds in 1990 would be $12 today. You can see the power of just 1% over the course of 24 years."
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Old 02-05-2015, 11:47 AM   #12
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I think it was Buffet who said Hedge Funds were a compensation scheme masquerading as an asset class.
Absolutely. Hedge funds are a way to make people rich: (the fund managers, not the fund's investors)
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Old 02-05-2015, 01:12 PM   #13
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Everyone seems to hate (for good reasons) hedge funds. The problem is finding investments that are not correlated with stocks/bonds. At least hedge funds are dependent on how well the managers models work not so much interest rates or the market.


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Old 02-05-2015, 03:22 PM   #14
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"... as measured by the HFRI Composite Index ..."
One thing to note about this index is that it is voluntary. Hedge fund managers can choose to report results or not. They can also choose what time frame to report. If they have one fund that performs well and one that does not, they can report only the better performing one.

I read this book The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True: Simon A. Lack: 9781118164310: Amazon.com: Books a couple of years ago.

My recollection is that cumulatively hedge fund managers are talented enough to make a lot of money. But, after the 2% of AUM and 20% of profits trim, investors on average made little.

Also, there is a large variance in return. So, some investors do see princely profits.

When a hedge fund does find the "secret sauce", two things commonly happen. As expected, a lot of smart people try to copy them (as one would expect in an efficient market) and the opportunity disappears. Secondly, a successful hedge fund will often hand back money to the investors so that they can keep future lucre for themselves. LTCM did this before they blew up.
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Old 02-06-2015, 07:26 AM   #15
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Yet every year there seem to be plenty of foundations, pensions, institutions and individuals investing in hedge funds. I never could understand it other than the "exclusive" sales pitch.
Some reasonable reasons (?) why big institutions do this:

They treat hedge funds as a special asset class to which they allocate a few % - which quickly adds up when you manage billions. The idea is not that they outperform but there is a good chance it will outperform by a wide margin while other categories don't, i.e. stabilizing overall performance.

Some hedge funds actually do know what they are doing and have a special focus, for example funding development in Africa.

Trying out new approaches in money management. If you are the first one to go for something new that actually works, the gains can be very large. Again, doing this with a few small % of your portfolio makes sense.

... and obviously the classic bad reason: while on average all hedge funds must lag the market, some will beat the market, either by chance or skill (who can really tell?). So if you get paid at an institution to invest, you tend to believe you can select the winning horse.

What's not like: betting other people's money in horse races. You get to be a rockstar and end up rich even if you screw it up. Very tempting .. especially when afterwards you can create a foundation and get additional praise for your philantrophy
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Old 02-06-2015, 09:08 AM   #16
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The CNBC segment on this mentioned something the article didn't mention I believe. The 1% plus annual expense fees are pounding the hedge fund compared to Buffets Total Stock Admiral fees of .05.


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I thought hedge funds also charged 20% of any gains.
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Old 02-06-2015, 09:11 AM   #17
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One thing to note about this index is that it is voluntary. Hedge fund managers can choose to report results or not. They can also choose what time frame to report. If they have one fund that performs well and one that does not, they can report only the better performing one.

I read this book The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True: Simon A. Lack: 9781118164310: Amazon.com: Books a couple of years ago.

My recollection is that cumulatively hedge fund managers are talented enough to make a lot of money. But, after the 2% of AUM and 20% of profits trim, investors on average made little.

Also, there is a large variance in return. So, some investors do see princely profits.

When a hedge fund does find the "secret sauce", two things commonly happen. As expected, a lot of smart people try to copy them (as one would expect in an efficient market) and the opportunity disappears. Secondly, a successful hedge fund will often hand back money to the investors so that they can keep future lucre for themselves. LTCM did this before they blew up.
How lucky for the LTCM customers that they were handed their money back.
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Old 02-06-2015, 09:18 AM   #18
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Typical hedge fund fees are 2 20. 2% of assets under management (AUM) plus 20% of the profit.


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Old 02-06-2015, 09:22 AM   #19
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I thought hedge funds also charged 20% of any gains.

They showed on the screen something like 1.2% in fees vs. the .05, but didn't mention any take on the gains. Either that was omitted or maybe Buffet was playing nice and not going to count that against him.


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Old 02-06-2015, 09:22 AM   #20
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I thought hedge funds also charged 20% of any gains.
Fees do vary. But, 2 and 20 is often quoted as the norm (2% of AUM and 20% of profits).

Steve Cohen's SAC Capital International has been in the news because the "secret sauce" seems to be insider trading. There's this about his fees:

Quote:
the fund earned the most money because Cohen charges some of the highest fees on Wall Street. While most funds impose a 1 to 2 percent management fee and then take 15 to 20 percent of the profits, Cohen levies 3 percent and as much as 50 percent, according to investors.
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