Posts filed under “Hedge Funds”
Larry Swedroe, research director for BAM Advisor Services LLC, noted earlier this month that total hedge fund assets under management, or AUM, reached $2.63 trillion. This represents a sizable increase, despite fund performance generously described as lackluster.
The increase in assets under management led to some interesting discussions. Lots of readers had e-mailed me with comments on both alpha — market-beating returns — and fee generation after last week’s column, “The Hedge-Fund Manager Dilemma.”
There is much more nuance to the discussion of hedge funds than is widely understood. Today is a good time to review some of the related issues. Let’s see if we can clarify some misunderstandings:
Some hedge funds generate a lot of alpha: Given the underperformance of the industry, why do so many investors want to participate in hedge funds? The most likely answer is the enormous alpha generated by a handful of star managers.
Last week, this came up in an interview with Jim Chanos of Kynikos Associates (I’ll post a link when its released). Chanos started Kynikos in 1985, when there were only a few hundred hedge funds. The concentration of talent — and alpha generation — became the stuff of legend.
What has changed is the sheer number of funds and the amount of assets they manage. What hasn’t changed is the reality that the best performers capture a disproportionate amount of alpha. The 9,500 new me-too funds are not, according to the most recent data, keeping up with the top hundred funds. Indeed, they are not even keeping up with their benchmarks.
Beating the market is hard: This is obvious, but let’s give some context. Outperformance is a rare and elusive thing. Consistently outperforming in any given five-year period is harder still. Add in the standard 2 & 20 fee structure (a 2 percent management fee along with 20 percent of any gains) , and managers must overcome the enormous drag on returns. Net of fees and costs, we hunt for the rarest of creatures: Funds that earn their keep. It is no wonder that so few funds can meet that challenge. But the lure of outperformance is only one aspect of their appeal.
Cognitive bias and behavioral driven investing: Meir Statman, a professor at Santa Clara University in California, focuses on the cognitive errors that investors make.
In a 2011 interview, Statman noted that people want more than just returns from their investments. They are also looking for the “status and esteem of hedge funds,” he said. It isn’t that different from “the warm glow and virtue of socially responsible funds” that send some investors in that direction. In both instances, performance takes a back seat to the emotional warm fuzzies investors feel. That feeling of belonging to a special club is why some high-net-worth investors are willing to pay up for mediocre performance. It grants them entrée to a sophisticated world they might not otherwise have.
We see this reflected in the mind share hedge funds occupy. Despite managing a relatively small percentage of total investable assets, they capture an unusual amount of media coverage. This may add to the overall mystique.
Selecting emerging managers: Experience has shown us this is an exceedingly difficult task. Beyond our own biases, it simply is a challenge to identify which managers will generate consistently good performance in the future.
The evolution of what happens to successful emerging funds helps to explain why. Some new managers identify unique alpha opportunities. These situations tend to be of modest size, perhaps a few billion dollars worth of market inefficiencies. Often, the emerging funds’ success attracts competitors, and the finite amount of alpha in that area gets fully mined. Very often, we see their success attracting lots of new capital, far in excess of what their niche can support and still generate market-beating returns. Sometimes, their success was simply random, a function of luck, and can’t be repeated or duplicated.
Hence, we are faced with a situation where fees are high, outperformance is rare, and our own biases undercut our ability to select managers.
Note that we haven’t gotten to the issues of hedging, market timing and stock selection. I plan on visiting these topic in a future discussion.
How Important Are Hedge Funds in a Crisis? Reint Gropp Federal Reserve Bank of San Francisco April 14, 2014 Before the 2007–09 crisis, standard risk measurement methods substantially underestimated the threat to the financial system. One reason was that these methods didn’t account for how closely commercial banks, investment banks, hedge funds,…Read More
I have been fairly fascinated by hedge funds for quite some time. I began studying them earlier last decade. It has been an intriguing field for investigation for a number of reasons: 1) Alpha Generators: In the early days of hedge funds, they created a ton of Alpha. Like pre-expansion sports leagues, there was a…Read More
A quick note this morning on anonymously stock tips, one I hope will be less cranky than yesterday’s screed. Greenlight Capital hedge-fund manager David Einhorn last month filed suit against the Seeking Alpha website, demanding to learn the identity of an unidentified blogger who had revealed that Greenlight was acquiring shares of Micron Technology Inc….Read More
Have a look at the tables above showing the performance of various investments during the five years leading up to the financial crisis lows, and the five years after. It leads us to a rather fascinating exercise, looking at complexity, cost and performance. Let’s start with the worst performers pre-crash: US Real Estate and…Read More
This weekend, I found myself in the rather unusual position of defending hedge funds. Before I explain why that is so unusual, allow me to explain what I was defending them against. Last week, Forbes released its annual score card of top-earning hedge fund managers. The usual gang was there: Soros, Tepper, Cohen, Paulson, Icahn,…Read More
Source: Bianco Research This month, 1,865 pages of FOMC transcripts from 2008 were released to the public. Bloomberg studied the transcripts, finding on average about 25 references to laughter per meeting of the Federal Open Market Committee. This was almost half of the 45 giggles per FOMC meeting in 2007. Continues here
“The $2.5 trillion hedge-fund industry, whose money managers are among the finance world’s highest paid, is headed for its worst annual performance relative to U.S. stocks since at least 2005. The funds returned 7.1 percent in 2013 through November, according to data compiled by Bloomberg. That’s 22 percentage points less than the 29.1 percent…Read More