Last week, I gave a very informal presentation to an audience of sophisticated HNW investors. Lots of family offices, none with less than $10m net worth; I’d ballpark the median > $50m. They get together regularly to discuss investing issues they are wrestling with.

The presentation was very general, including my (non)outlook on the economy, markets, investing, etc.

During the Q&A portion, issues of asset allocation, indexing, tactical adjustments, rebalancing, behavioral economics, and more were batted about. One of the questions that came up was fund manager under-performance. Starting with the usual data points — 80% of managers miss their benchmark, etc. — we then discussed why family offices, foundations and institutions were so willing to pay 2+20 for what is sub-par performance. Yes, 2011 was a rough year, but the problem seems to go much further than that.

One of the questioners asked, and surprised himself with the answer:  “Based on all this, then why do we bother picking hedge funds anyway? Why shouldn’t we simply index?

Why shouldn’t you, indeed? I replied that I thought indexing made sense for many HNW investors, but I favored a form of tactical overlay versus straight Buy & Hold. (We’ve discussed the 10 month MA as a simple sell signal). We never got to discuss the incentives that drive consultants to sell these folks on the belief that they can consistently select managers who can out-perform; that is worthy of a full discussion some other time.

The most interesting part of the discussion was almost an afterthought. After stating that, yes, there were 100s of very talented hedge fund managers — out of a pool of 10,000 — I asked the group this: How can you find these outstanding hedge fund managers? How can you evaluate whether to give them your capital? How successful have you been at this?

No one had much of an answer.

We know exactly who the superstars are ex post facto. But we don’t get to retroactively go back in time to give our money to Jim Simmons or Ray Dalio. I told the group that I am “awful at selecting managers who don’t have a 10 year track record of out performance; (though I redeem myself by knowing when to fire a manager).”

But  the really interesting part came in the form of a challenge to the group: “Who is good at picking Hedge fund managers? Who amongst you has the ability to consistently evaluate managers who then outperform over time? Not only that, but outperform on an after fee basis?”

Their was a stunned silence.

I continued: “I do not have that skill set. Evaluating hedge fund managers based on the information that is currently shared is not my forté; more importantly, I doubt YOU have the skill set to pick hedge fund managers. (if you did, why are you here?)”

I pointed out the simple fact that most of us are not well equipped to evaluate managers. The ability to evaluate someone based on either understanding their approach and temperament was not what most of us were capable at. I continued:  “That is what Excel is for; You mark down the quarterly and annual track record managers you select (monthly performance data is mostly noise), keep a list of the qualifications you used to make that decision. Then you track their performance net of fees. How have you done?

More silence.

Understand exactly what I am saying: Its not that there aren’t 100s of managers worthy of your capital — there are 100s maybe even 1000s who are. However, you simply are not well equipped to pick them. Sure, we can look at long-term track records. Bridgewater is Institutional only; Renaissance Technologies returned outside investor monies; There are lots of well known funds doing extremely well over a multi-decade plus period — but good luck getting them to take your money at this stage.

Time was up, the moderator thanked everyone, but the question remains:  How many investors can consistently select hedge fund managers who beat their benchmark over long periods of time after fees?


2011: Disastrous Year For Mutual, Hedge Fund Managers (January 17th, 2012)

When Do You Fire a Manager? (April 5th, 2011)

Category: Hedge Funds, Investing, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

30 Responses to “Is Anyone Any Good at Picking Hedge Fund Managers?”

  1. “… Starting with the usual data points — 80% of managers miss their benchmark — we then discussed why family offices, foundations and institutions were so willing to pay 2&20 for what has turned out to be sub-par performance…”


    with the above, What were the Answers/Rationalizations?

    were they “too busy” to learn the basics of.. ?

    “too busy” ~ more interested in their ‘coke spoon’/next VaKay/whether there’s ‘Equity’ in their GL430 that’s coming ‘off-Lease’…

  2. InterestedObserver says:

    Since it seems pretty well established here that most folks have difficulty figuring out what has already happened in the past – cognitive dissonance, ideology, and so on blinding the retrospective – it would seem painfully obvious that coming to grips with the future, even if it identifying someone who can, is beyond reach. Same psychology and biases are in play.

    How many of the decisions that we make every day are based on really hard data? Focus on the important ones. When I ponder that myself, I sometime break into a cold sweat.

  3. dead hobo says:

    BR wondered:

    we then discussed why family offices, foundations and institutions were so willing to pay 2+20 for what is sub-par performance.

    In these cases, it’s OPM twice removed. It’s not the pension fund manager’s money; it’s the retiree’s. Then it goes to the money manager as OPM. I would suspect it’s nearly impossible for a money manager to personally not have a good year financially since their earnings come primarily from management fees. The pension manager is probably salaried. While all would like to earn fabulous percentages on invested capital, the industry allows excuses such as “we beat others in this category” to suffice when capital losses are posted. Plus all capital managers on TV have really great personalities. I wish I was 1/2 has charming as most pundits.

    Also, with respect to pension managers, accounting rules allow them to bury huge financial losses providing they have ‘expected earnings’ based on high assumed yields that turn out to be massively too high. I doubt most people understood anything I wrote a few weeks ago when BR complained about unrealistic assumptions from pension managers. BR appeared to believe they were just stupid with respect to economics and current events. No, BR was naive and the pension managers were clever. Pension accounting allows pension managers to deeply bury losses due to expected earnings being significantly lower than actual earnings. Just being a little off would be recorded in the books immediately. Big losses go into the comprehensive earnings section nobody reads and the actual loss is taken over a period of many years, hopefully being offset by a gain in later years with nobody ever being the wiser.

    Plus, Mark E Hoffer has it right. Money management is hard and people follow strange motivations. I suspect these are some of the people who buy when I am selling and taking profits so I really appreciate their support.

  4. rd says:

    The markets have trended upwards on a real basis over the past century and a half. Nearly all mutual funds are effectively long only, so even if you lost a percentage point on the markets, you still come out reasonably well in the long run (20 yrs +) with an average mutual fund mamaner if you “buy and hold”. Low-cost index funds have given the average investor the ability to effectively track that long-term performance with very little penalty.

    There used to only be a few hedge funds. They were executing unusual strageies that the vast majority of the market was not positioned to. That gave them a golden age of returns in the 70s through the 90s. However, like all things financial, success attracts a crowd. It is not coincidental that most of the legends bailed out over the past 20 years because they realized they were playing with large dollars in an increasing crowded space.

    Hedge funds can do lots of speculating using positions and tools that the mututal funds and pension fund managers generally can’t do directly. However, that also means that they are often making bets in the opposite direction of the long-term upward trend. Betting against the trend, an increasingly large group of people, and generally few restrictions on what they can do implies that you would expect to have a much more variable set of returns from hedge fund managers than from the traditional investing. The ability of this group of people to bet against the market direction means that they also have the ability to vastly underperform if their bets are in the wrong direction consistently.

    Since there are now thousands of hedge funds, it is not surpising that they are struggling as a group given that their fee structure would make a even a traditional mutual fund manager blush. I think one of the final nails in the financial coffin that this secular bear market is going to bang in will be a massive reduction in the number of hedge funds out there.

  5. constantnormal says:

    No system works all the time … I cannot even confirm if a system exists that works half the time …

    Predicting is always a hazardous business, especially when it involves the future …

  6. dead hobo says:

    Whoops, I said

    Pension accounting allows pension managers to deeply bury losses due to expected earnings being significantly lower than actual earnings.

    This is just backwards. If your expected earnings were booked as $$$$$$$$, but your actual earnings were only $ or -$$$, then this difference is taken as a loss over time and buried in the books until such time that the fund actually makes a lot of money to offset the difference between expected earnings and actual earnings.

    Pension accounting is covered in 2nd semester 2nd year undergraduate accounting. It is the hardest chapter in the book. It also explains why pension managers just can’t seem to notice that high expected rates are unrealistic.

  7. Orange14 says:

    Greed is a very powerful motivator and I use the term quite broadly here. Most investors want outsized returns on their money and whether they self-direct or look for a money manager (hedge or otherwise) they want to do better than the averages (prime example Bernie Madoff – ask yourself why did reasonably intelligent people/organizations invest with him???). As has been shown time and time again, doing so is extraordinarily difficult and most should stick with simple index funds and not lose sleep worrying about where things are going (of course they do need to be cognizant of what the money is needed for, e.g., capital appreciation, retirement, etc.).

  8. Richard says:

    I’ve been in hedge funds for 10 years, starting as an Analyst and working up to be a Portfolio Manager over the past several years. I feel there are very few large funds that I would invest my money in, and as a small investor or family office I really believe the answer is understanding people’s psychology, their ability to think against the grain – oftentimes this is converse to a managers’ marketing skills. A few thoughts:

    1) Large funds tend to manage risk and leverage well, until they don’t. Citadel at its peak had in excess of 10x leverage. SAC is levered 3-4x. The Tiger affiliates typically have 250-350% gross exposure.

    2) Small funds do not have the internal risk management capabilities of large funds, but presumably should be more nimble and able to take directional trading exposure well. The problem is, most small funds are started by people who worked at large funds and as such aren’t oriented to generating profit through trading nor through directional exposure management.

    Since the profits of hedge funds are supposedly to be correlated to an overall smarter talent pool and economic incentives (a profit share) – I think it’s plainly evident where one should be focused – younger managers managing smaller amounts of capital, who, most importantly, show the psychological characteristics of being highly competitive, wanting to win, and quite frankly, wanting to become really, really rich themselves. You want the guy who is staying in the office until midnight, poring over 10-Qs and 10-Ks to ‘get’ that snippet of detail that others are overlooking.

    Unfortunately, no offense but old, rich, white people while they intuitively ‘get’ this – their own embedded biases and life experiences insert great discomfort with this kind of approach.

    In which case I would just advise investing in a diversified fund of funds and getting back to your game of golf.

  9. CANDollar says:

    Great comment rd:

    Through innovation that exploit smaller opportunities beyond what the economy offers the financial services industry is arbitraging itself out of existence.

    Insider trading and other market failures may end up being the only edges left to gain an advantage over the indexes.

  10. streeteye says:

    Not only do you need to evaluate them, but you need to identify the ones with potential to outperform early in their lifecycle, since that’s where most of the outperformance happens. And have access to them at that time. And be able to do due diligence to avoid a Madoff or other disasters.

    Somewhat parallel to venture capital – a substantial portion (all or more?) the outperformance goes to the top firms that a super-hot startup is willing to take money from. Good luck getting any of those VCs to take your money if you haven’t been with them since the beginning, or if you’re not Yale or a similar large, prestigious, patient investor.

    I guess that’s why some people do funds of funds, but then that’s another layer of enormous fees.

    Hedge funds have their place, but they’re really a vehicle for true superstar fund managers, who are few and far between. The fact that they did really well caused the industry to grow rapidly, but it’s not the vehicle, it’s the manager, and a lot of the managers that popped up all over the place are not necessarily any better than mutual fund managers.

  11. Simply-Put says:

    The same can be said for mutual fund managers and financial planners most can’t beat the indexs with regard to issues of asset allocation, indexing, tactical adjustments, rebalancing and behavioral finance. So who do you trust? The answer is youself, because you can’t learn from someone else’s mistakes. And for the well-heeled investors I recommend the library. They can read books on Game Theory, MPT, Portfolio optimization, Inter-market Analysis, Secular Bull and Bear Markets, Technical Analysis and of course business cycles.

  12. Mark Down says:

    “Very Informal Presentation” ………..Strolling for clients on a cookies and coffee budget!


    BR: telephone conference, no slides allowed (their rules)

  13. cognos says:


    There are a bunch of false assumptions in your question:

    1) Never be surprised that people at conferences or listening to talks aren’t any good (audience selection bias). Or the people who are there, who have done well… what would make you think they would speak up? This is seldom rewarding.

    2) What benchmark does the HF have to beat? Lets say I propose that your “family office” enter into a 4x leverage swap with DeutscheBank and post $25mln in collateral. The equity swap desk will then invest on your behalf $100mln in hedge funds and create a tax-advantage derivative “call option” that will gives you the returns on that $100mln hf investment in exchange for LIBOR+100bps against your $75mln borrowed.

    As long as the first 6-12 months are good returns (drawdown risk).
    And the pool of hedge funds does 8-15%.
    Your returns on equity will be 30-55% avg annual IRR for 5-7 years.

    So… yes, you are running a bit of “2008″ risk… but otherwise you have a 95% outstanding investment. This was an oft taken option by well-run family offices in the 2000-2008 era. 9-out-10 of such investments paid outstandingly. Many were levered into 100s of millions, probably a few into $bs.

    The point missed by your “outperformance versus benchmanrk” is that a pool of hedge funds is very very very low vol. Thus its “performance” hurdle is very low. If you disagree… please go back to the top and apply leverage.

    3) Why don’t you assume the occasional 1/25 outstanding hedge fund investment makes up for the other 24? [BR: Cause I try not to assume anything]

    4) The real problem with hedge funds… is the taxes US individual investors pay. On a after-tax basis the US tax code tends to favor 2 simple investments – real estate and small businesses (cap gains and the ability to deduct expenses). That said, if any investor holds ANY significant cash, they cannot concern themselves further with taxes because cash or fixed income is so negatively taxed bias that all further risk investments become “tax symmetric”.. i.e. gains are taxed, but losses are deductible. So only investors willing to completely avoid cash (leverage real-estate investors for example) can look at more marginal tax decisions.

    5) Finally, many of the richest families in europe, asia and the US are heavy users of “investment partnerships” like HFs and PE. This is because they are typically far better than naive stock investments. I.e…. follow the money.

    In summation, I think your whole starting point is 100% wrong. I’ve said it before… it 2008 HFs did -20%… the worldwide equity markets did -40%. There were only $2T in hedge funds… probably $40T in worldwide equities. Why aren’t you pointing out that the $40T would’ve ALL been better off in HFs?

  14. cognos says:

    Today there is $5T in UST Tbills earning 10bps.

    There is probably another $10T in banks earning sub-30bps “cash rate”.

    Why aren’t you pointing out that this money should be in HFs? It would earn far more.

    (Again, this is working on the “benchmark” issue. What is the appropriate benchmark?)


    BR: Which hedgefund should they be in?

  15. orthoman says:

    Alpha exists but (a) is not sufficiently persistent to enable analysts to select good managers with regularity; and (b) is both negative and positive, and generally has the same sign in the aggregate as its strategy indices.

    “Investible Benchmarks and Hedge fund Liquidity”.

  16. New York City retains crown as Hedge Fund Hub of the World; Top 100 oversee $350 Billion
    January 23rd, 2012

    The list of the Top 100 U.S. Equity Hedge Funds from the greater New York City area has been released, revealing that the top hedge funds oversee a combined $348.5 billion in equities. Not surprisingly, Midtown Manhattan houses the majority of the hedge funds. In fact, just four midtown zip codes (10017, 10019, 10022 & 10153) are home to fifty-nine of the hedge funds on the list.

    The 50-story General Motors Building at 767 Fifth Avenue in midtown is home to eight of the top 100 hedge funds, including such industry renowned equity stars as Carl Icahn’s Icahn Associates and Maverick Capital’s Lee S. Ainslie. Not only is the GM Building known for its high profile tenants, but it is also known for having some of the most expensive commercial office leases in the country.

    520 Madison Avenue, which is just four blocks down the street from the GM Building, is the second most popular building for top equity hedge funds, housing five of the top NYC funds. Among 520 Madison’s tenants are John Paulson’s Paulson & Co (#2 on the list), as well as Robert Pohly’s Samlyn Capital and Steven Cohen’s Sigma Capital Management.

  17. louis says:

    Does it matter if the manager can change their original philosopy at any time?

  18. Brett Arends says:

    Assessing the Performance of Funds of Hedge Funds,” a research paper produced by Benoit Dewaele and Hugues Pirotte of the Universite Libre de Bruxelles (the Brussels Free University in Belgium), and Nils Tuchschmid and Erik Wallerstein of the Geneva School of Business Administration in Switzerland. The paper is here.

    They studied a broad sample of 1,300 funds-of-funds from 1994 through 2009, and analyzed just how much value they actually created.

    Their core finding? When you strip out the fees, just 22% deliver any “alpha,” or risk-adjusted investment gains, at all.

    And most of those gains came from the underlying hedge-fund indices, rather than from picking the right individual managers.

    How many actually added value by picking the right managers, and avoiding the wrong ones?

    According to the study, just 5.7%. That’s right. After deducting fees, just one fund in 20 actually added risk-adjusted returns above those of the underlying hedge-fund indices.

    Nearly half of all Fund of Hedge Fund managers, the academics report, delivered “negative after-fees alpha when benchmarked against the hedge-fund indices.” In other words they couldn’t even keep up with the index.

  19. cognos says:


    Sounds like the basic point is 1+1 = 2.

    You say,

    “Nearly half of all Fund of Hedge Fund managers, the academics report, delivered “negative after-fees alpha when benchmarked against the hedge-fund indices.” In other words they couldn’t even keep up with the index.”

    Duh! Isn’t that the point of an “index”?

  20. [...] Selecting good hedge fund managers is tougher than it looks.  (Big Picture) [...]

  21. cognos says:

    BR –

    Yeah, I certainly agree with the point that FOHF should simply index broader baskets of hedge funds.

    Its funny and odd that the HF community still hasn’t picked up on this “stock” point from the 1980s. There is still fear of investing in the “small cap value” HFs which dramatically outperform. Simply because of the occasional fraud or bad failure… rather than seeing the “avg” perf of a group of investments.

    And the savings on non-value-added consultants, all the useless “due diligence”, etc. Just index a broader basket… and measure. Its pretty basic arithmetic.

  22. streeteye says:

    cognos – so which HF index is comprehensive and tradable?

    the biggest, most successful HFs don’t report to indexes, and are closed to new investors.

    The smallest, don’t report yet.

    The ones that report, don’t exactly look kindly on people constantly trading in and out to manage exposure to match an index.

    between the above, side pockets, illiquid investments that may or may not be marked to market, redemption freezes, the notion that HF indexes are investable or that an index strategy is likely to be successful seems far-fetched.

    If you’re Yale, you can find outperforming managers early, that are doing unusual things that won’t correlate, you can do due diligence, etc.

    If you’re not, the odds are stacked against you.

  23. CANDollar says:

    So if the majority of managers, hedge fund and mutual, do not beat indexes then someone has to come up with a portfolio management model that costs, say 0.4% of assets under management.

    The most liquid ETFs have fees well below this. Fixed income costs less.

    Even if you overlay some kind of basic risk management – the 10 month moving average talked about much – this is just several trades a year, if that.

  24. ValuValu says:

    What if the Hedge Fund model was obsolete, and should be replaced by a ‘smart indexing’ method?

  25. wealthknowledge says:

    BR – That wasn’t “stunned silence.” The 25 participants on the call were all put on “mute” by the operator to avoid a free-for-all. Really.

    Looking forward to your visiting a group meeting in person and participating in a more interactive conversation.

  26. MB says:

    Choppy markets have reduced hedge fund profitability, more than 50% of hedge funds lost money in 2011. The FT reports that 2/3 of hedge funds are below their high water marks, meaning no incentive fees until performance rises back above that level. The angst created by reduced hedge fund payouts must be making traders more skittish.

  27. A bit late on the thread but, maybe the comment will help someone out there. Peter L. Brandt (of did an interview with the guys at Mercenary Trader (, you can register and receive access to the interview) where he talked about building a pool of money managers. Peter is a meticulous risk manager so his approach was to focus on losses incurred instead of profits earned. He essentially found that selecting the ten or so managers that had the best risk management practices (i.e. incurred lowest percentage of loss during down periods) resulted in the best overall performance because the same managers were most effective at maximizing their gains. Any down periods from one manager were more then covered by the performance of the other managers. So building a pool ten or so risk focused money managers and distributing money evenly amongst them is an extremely good solution for HNW individuals.

  28. EIB says:

    The hedge fund scam is finally being exposed. Another 20 years, and people might actually catch on?

    The HFR Global Hedge Fund Index puts the industry’s annualized return from 1998 to 2010 at 7.3%. In Lack’s mind, those return figures are distorted by several factors. One is that these returns are calculated on a time-weighted, rather than asset-weighted basis. As he shows repeatedly in the book, both fund and industry performance suffers with growth in size (he calculates the correlation between hedge fund size and performance as -0.42). In other words, the index numbers overstate the strength of hedge fund performance due to stronger results in the early years when hedge funds and the industry itself were both smaller. His conclusion: from 1998-2010 the index returned only 2.1% annualized on a money-weighted basis, not 7.3%.
    And to add insult to injury, Lack notes that HFR Global Hedge Fund Index returns are also overstated due to statistical biases such as “survivorship” (lousy performers shut down or stop reporting) and “backfill” (strong performers start to report). Academic estimates are that these statistical biases of self-selection (reporting is optional for the largely unregulated hedge fund industry) add 3-5 percentage points to index returns. Adjusting for these biases, Lack estimates that from 1998-2010 investors collectively lost $308 billion in hedge funds while the industry earned fees of $324 billion.

    Add these findings to the mountain of evidence that shows that self-reported hedge-fund data is riddled with such biases. For example, a Journal of Asset Management paper found that so-called survivorship bias — excluding companies that no longer exist from performance analyses — added 4.4 percent per year to hedge-fund returns. A study by Princeton University professor Burton Malkiel that appeared in the Financial Analysts Journal also found that “backfill bias” — which occurs when hedge-fund managers report their performance retrospectively, presumably after they have had some success, rather than from the inception of the fund — overstated returns by 5 percent per year.