Hedge Funds

[2B]

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

 

[ERD50]

From the article:

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.

-ERD50

 

[ERD50]

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

-ERD50

 

[MichaelB]

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

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.

 

[Mulligan]

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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[audreyh1]

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.

 

[Independent]

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

 

[karluk]

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.

 

[Mulligan]

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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[gcgang]

I think it was Buffet who said Hedge Funds were a compensation scheme masquerading as an asset class.




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[mikelish]

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."

 

[robertf57]

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)

 

[INTJ10]

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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[adrift]

"... 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.

 

[Totoro]

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

 

[audreyh1]

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.

 

[audreyh1]

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.

 

[INTJ10]

Typical hedge fund fees are 2 20. 2% of assets under management (AUM) plus 20% of the profit.


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[Mulligan]

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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[adrift]

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:

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.

 

[audreyh1]

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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I an surprised that is not included, as that is one standard reason hedge funds are expensive. Too bad they don't refund 20% of the losses, either. People investing in them are hoping to have the fund "hit one out of the park", so they don't care about the cut of the gains. But, gee, 2% of the AUM is also horrendous.

Ooo - ouch, adrift! 3% and up to 50% of the profits. And insider trading too?

That seems to skirt close to the Manoff fraud.

These aren't like mutual funds where you have a board looking over the fund managers and what is owned is public. These hedge funds look ripe for fraud.

 

[harley]

Here's another article about the bet, sent to me from another ER member. Thought I'd add it to the discussion. It's from the CFA Institute - Betting with Buffet Seven Years Later

There's a fair amount of "sort of" acknowledging that they (hedge funds) are losing, with a liberal sprinkling of "not fair". The S&P isn't the appropriate index to compare against, it's the Fed's fault, it's not really the fees, we might do better in the next three years, etc. But there's a good chart in there that show's that over half of the underperformance of hedge funds is due to fees. But a lot of good information in the article, not the blurb format of the others I've seen.

My favorite part of the article is where they talk about how they invested the money for the million dollar payoff to charity. They originally (2007) put $640K into a zero coupon bond at 4.5%, so it had grown to $950K by the end of 2012. They then moved it into BRK stock, and it had grown to $1.6M by the end of 2014!

 

[Totoro]

I agree that S&P 500 can be argued as an inferior benchmark compared to global hedge funds. The MSCI world index is better.

Guess what: it still outperforms our fund of hedge funds

While the explanation where the difference comes from is interesting, it is also irrelevant in so much that all of the explanations are structural factors:

• Stock loan fees are a part of their business
• Management fees obviously too
• Beta mismatch implies there is lower volatility in hedge funds, is that true?
• Market exposure is a non-issue: hedge funds are free to choose where they put their money, that's the whole point.

All this points to the same conclusion: any outperformance within the (fund of) hedge funds results in the managers getting rich, not the customers.


As I argued elsewhere, there still might be value in going with a hedge fund for a small part of your portfolio to diversify and/or experiment, but not for the bulk of your capital.

 

[ERD50]

Here's another article about the bet, sent to me from another ER member. Thought I'd add it to the discussion. It's from the CFA Institute - Betting with Buffet Seven Years Later

There's a fair amount of "sort of" acknowledging that they (hedge funds) are losing, with a liberal sprinkling of "not fair". The S&P isn't the appropriate index to compare against, it's the Fed's fault, it's not really the fees, we might do better in the next three years, etc. But there's a good chart in there that show's that over half of the underperformance of hedge funds is due to fees. But a lot of good information in the article, not the blurb format of the others I've seen.

....

Wow, what a bunch of losers!

Regarding the S&P 500 benchmark, check this one (bold mine):

We believe the S&P 500 is not an appropriate benchmark for a portfolio of hedge funds. That said, it’s hard to fault Warren for choosing the S&P 500 as a proxy.

Ummm, "hard to fault Warren"? You made the bet, right? You agreed to the conditions, right? But now, after the fact, it is not an appropriate benchmark? Oh, but you're not going to fault Warren for your apparent mistake? How big of you. Grow a pair!

What a long list of weak excuses. From the wrong benchmark, to low interest rates, to the US market wasn't supposed to do so good and international wasn't supposed to do so bad (but I thought you guys were supposed to 'know' these things?), to 'how about best 2 out of 3?'. Pathetic.

Reminds me of:

Warren should make this on ongoing bet, keep it running for every year for every 10 year period until they cry 'Uncle'!

I wonder if the numbers are available for a backtest throughout the 90's and 00's?

-ERD50

 

[MichaelB]

Here's another article about the bet, sent to me from another ER member. Thought I'd add it to the discussion. It's from the CFA Institute - Betting with Buffet Seven Years Later

Codswallop and tarradiddle! This is one for the ages. What a great link, harley!

For others, the essay is written by one of the hedge fund managers that made the bet with Mr. Buffet, "explaining" the apparent poor performance . His response here is classic BS. Distract with meaningless statistics, world class spin and double-talk. Say the benchmark is the wrong one, then blame the Fed. He even calls Mr. Buffet's strategy a "headwind".

This part is true marketing

As we intend to show, the residual performance after adjusting for the impact of this investment environment manifests a return stream that could have been beneficial to a diversified portfolio of risk assets under different circumstances.

Translation - we're not losing, we just need to adjust for the difference in score.