
Hedge funds turn out not to work: average fund down 17.6% for the year - pg
http://www.nytimes.com/2008/10/23/business/23hedge.html?em
======
anthonyrubin
The recent financial reporting has been pretty atrocious.

"This unregulated, at times volatile corner of finance which is supposed to
make money in bull and bear markets lost $180 billion during the last three
months."

Our financial systems are heavily regulated. The specific regulations that the
author would like to see may not exist, but this does not justify claiming
that hedge funds are unregulated. Many people seem to believe that all risk
should be regulated away and actually believe that this is possible. More
information on current regulations that hedge funds are subject to:

[http://www.forbes.com/opinions/2007/04/13/hedge-fund-
regulat...](http://www.forbes.com/opinions/2007/04/13/hedge-fund-regulation-
op-ed-cx_pw_0413hedge.html)

"Many hedge fund investors, particularly the wealthy individuals, are
flabbergasted by their losses this year. The average fund was down 17.6
percent through Tuesday, according to Hedge Fund Research."

The S&P 500 is down 40% for the year.

~~~
jbrun
Agreed, I would have like to be down 17.6% this year instead of whatever I am
actually down. Luckily, I pulled most money out last spring to travel and
start a company - best investment I have ever made!

~~~
nostrademons
I'm only down 2%. You can give me all your money and I'll invest it. Or
rather, I won't, but that will save you even more money!

(And then you can curse me when we get hyperinflation, the stock market shoots
up, and all that cash becomes useless.)

~~~
jimbokun
Did you cash out because you suspected the market was due for a big
correction?

Or were you just lucky to have assets in cash at the right time?

~~~
nostrademons
A little of both.

When I was first starting my startup, I figured I ought to rebalance my
portfolio just so I could forget about it while I worked. Tallied everything
up, divided them up by asset classes, and figured out what dollar value I
wanted in each fund. And I moved some of it around, into bonds and out of
individual stocks and such.

But when it came to putting money _into_ an S&P 500 index fund, I just
couldn't do it. I had the Vanguard website open, everything ready to invest,
form filled out, but my gut told me that there was no possible way that the
stock market was worth what the ticker said it was worth. I'd previously
worked at a financial software startup, so I had all the stats on market P/E,
record earnings, leverage levels, etc. So I closed the window and forgot about
it.

This was on Oct 5. The S&P 500 peaked on Oct 11.

So yeah, a whole lot of luck, and maybe a little knowledge thrown in. I tell
this story because everyone here's coming up with excuses for hedge funds:
they're "only" down 17.6% when the market is down 40%, or they got those
outlandish returns with less risk, or they're really really smart and so
should be compensated for those sophisticated quant models. But excuses don't
matter in finance - only your return. Ultimately, it's a whole lot of luck and
a little knowledge - _for everybody_. I predict we'll see many, many more
hedge funds do a lot worse in the coming year.

~~~
lief79
So, at what point are you going to reverse that decision, or what do you think
are currently good investments for a retirement beyond 20 years from now?

Especially passive management investments?

~~~
nostrademons
I think the market is pretty close to fairly-valued now, by conventional
valuation measures. Maybe still a little overpriced, but you can't call the
exact bottom.

I'm waiting to put money in because I don't yet have a job, and so may need
that cash to fund another startup (there's that luck aspect again; had I not
been starting a startup last year, I likely would've had way more in the
market). But if I had a normal employment situation, I'd be gradually money
into stocks, towards a more normal asset allocation.

As for a retirement 20 years out - I wouldn't even try to predict that. I
haven't touched my Roth IRA this crisis, nor do I count it in overall returns
(haven't even looked, really). The one thing I _would_ say is to have some
international exposure. Prices rise or fall based on how reality compares to
the market's expectations, and I think it's unlikely that America in 20+ years
will have the hegemonic position it does now.

------
andr
That's not the full picture, really.

1) Since a large chunk of the money on financial markets flows between funds,
and this is pretty much a zero sum game, the average hedge fund performance is
bound to be around 0%, other things being equal. It's your fault if you pick
the wrong hedge fund, or you don't know the risks.

2) A lot of hedge funds do not target an absolute return, but rather a return
on top of the market's return (and they pick an index or several which they
consider to be "the market"). So if the market is down 20%, but funds are down
17.6% on average, then they have actually made a 2.4% average return compared
to the index they follow. As weird as this may sound, this is actually a
success for them. They would usually get a cut of the 2.4% gains as their
commission.

One of the main reasons is that absolute return funds are mostly quantitative
and/or derivatives-based, and those are much harder to do than buying stocks
by your gut feeling (which is what a large number of funds do, really). The
other reason is that when a fund is big ($5bn+) it is very hard to move your
positions around quickly (as would be required for an absolute return
strategy), without shaking the market, and losing money in the process.

~~~
nostrademons
That's some pretty funny accounting.

By your first point, hedge funds _are_ the market, and so between all of them,
ought to average exactly the market returns. By your second point, they
measure their returns against the market, and so on average should return 0%.

Why should anyone ever invest in hedge funds, under these premises?

A much simpler (and probably truer) explanation is "What goes up, must come
down." Hedge funds booked large paper profits during the boom; now it's time
for them to book large paper losses in the bust. Except that if their
customers get scared, those large paper losses turn into large actual losses.

~~~
andr
Ah, but you missed the "other things being equal" part. ;) If the markets move
as a whole and hedge funds are heavily long on the market, but others are
market-neutral, or even short, things are not equal.

~~~
nostrademons
Right, but on the whole, you'd expect those all to average out. If the markets
move up and hedge funds are long, they're as likely to move down while hedge
funds are long, or move up while hedge funds are short.

~~~
andr
That is why better hedge funds know when to be long and when to be short. My
explanation makes a lot of assumptions for simplification, because it is
impossible to know what every hedge fund is doing at every point in time.

------
lacker
This article is pretty bad along with most NYT financial news coverage.

A lot of critics blame everything on deregulation. But the big banks were the
most regulated part of the financial system, and they have imploded. Meanwhile
hedge funds have the least regulation, and while they haven't been making
money, they at least are not threatening to destroy our financial system.

The Economist had a much better article on hedge funds in the aftermath of the
financial crisis.

[http://www.economist.com/finance/displaystory.cfm?story_id=1...](http://www.economist.com/finance/displaystory.cfm?story_id=12381701)

Particularly, hedge funds have not been allowed to hedge! If the government
bans short-selling in the hardest-hit stocks, don't be surprised if a hedging
strategy doesn't work any more.

~~~
jimbokun
"But the big banks were the most regulated part of the financial system, and
they have imploded."

I think this is not true.

It is my understanding that it was the big, less regulated investment houses
that got into a lot of trouble with mortgage securities. The heavily regulated
retail/commercial banks haven't suffered nearly as much.

Unless we are defining "banks" differently...?

~~~
lacker
Yeah we are defining "banks" differently - I was considering both "investment
banks" and "retail banks" as types of banks. You are right that retail banks
haven't suffered as much, but considering Washington Mutual and Wachovia
collapsing and several others signing on to the government equity purchase
program, they're definitely costing the taxpayer more than hedge funds are. So
far, at least....

------
charlesju
Seems like that's still a pretty good investment if the market as a whole is
down 40%.

~~~
pg
Stocks are down. Gold is up.

Hedge funds don't just invest in stocks. They can bet on anything, including
stocks going down. This is supposed to allow them to make money in down
markets as well.

~~~
senthil_rajasek
Gold is actually down, trading near its 52 week low

<http://www.marketwatch.com/quotes/gc08z?sid=1633395>

I agree that hedge funds can invest in anything (unlike MFs, which are
regulated) but if you look at the short term (4-week) T-bills their interest
rates are down by as much as 62% since 2002, so the general consensus is that,
that is where most money is getting drained.

Why? They are the most conservative, safe investment choices available. If I
may digress, this is not a good thing for the economy as we are not using that
money to produce anything.

Considering the Dow is down over 30% and counting for the year, 17.6% down
seems impressive to me :-)

~~~
pg
_Gold is actually down, trading near its 52 week low_

Oops, sorry, was relying on a news story I saw a couple weeks ago. It was
doing better than the stock market a couple weeks ago, though, which was what
I was getting at.

------
fbbwsa
obviously they DO work then, since most indices are down 40% on the year.

Hedgefunds are designed to outperform benchmark indices. Outperforming by 23%
is phenomenal.

By the logic of the poster, a year where the SP500 returned 50% and a fund
returned 10% would be proof that hedge funds DO work. That fund manager would
be immediately fired.

Hedge funds have outperformed for the last 10 years. Taking a one year
performance that loses money doesn't mean anything.

------
maurycy
It happens because there is also a silent run on hedge funds that are forced
then to close their positions, bringing, even sound, assets down.

The other reason is highly leveraged funds when the margin requirements went
up after interest rates raise.

~~~
bd
From The Economist article:

 _All this means that hedge funds have been unable to ride to the rescue of
global markets. According to the IMF, the average cash balance of hedge funds
has risen from 14% last year to 22%, while the amount of leverage (borrowed
money) they use has fallen from 70% of capital to 40%. In theory, that gives
them the firepower to buy now that prices have fallen; in practice, they may
need their cash to repay clients that want to redeem their holdings._

You are only as smart as your dumbest investor is.

~~~
maurycy
Means that hedge funds should hedge against their own investors, too.

------
anthonyrubin
BTW Paul, why did you post this? Do you believe this drivel or were you trying
to incite discussion?

~~~
maurycy
Hedge funds exploit the system, as we, hackers, do.

------
Dilpil
This does not prove hedge funds do not work. It only proves what we already
knew: active investing is a zero sum game.

This is tantamount to claiming that poker doesn't "work" because the "average"
player breaks even.

~~~
hugh
I assume what was meant was that they failed in their job of hedging. Hedging
is supposed to involve taking a very conservative position to protect against
losses.

This, I assume, is a bit of a joke since hedge funds have largely turned into
speculation funds which take risky positions in the hopes of large returns.

~~~
andr
They actually succeeded in hedging, because they halved their losses compared
to the market.

Hedging doesn't mean you always make money. It means that if your main
instrument falls, instrument B is going to go up and cover some of the losses,
but not all of them.

~~~
helveticaman
The term "hedge fund" is a leftover from times when it wasn't a catch-all for
investment firms for qualified investors. As the other kind of firms had their
ups and downs, hedge funds expanded into their space. By now htey are so well
established many firms that aren't technically hedge funds (because they do so
many other things and may not do any hedging at all) are called hedge funds.

From <http://en.wikipedia.org/wiki/Hedge_fund#History>:

Sociologist, author, and financial journalist Alfred W. Jones is credited with
the creation of the first hedge fund in 1949.[2] Jones believed that price
movements of an individual asset could be seen as having a component due to
the overall market and a component due to the performance of the asset itself.
In order to neutralise the effect of overall market movement he balanced his
portfolio by buying assets whose price he expected to rise and selling short
assets he expected to fall. He saw that price movements due to the overall
market would be cancelled out because if the overall market rose the loss on
shorted assets would be cancelled by the additional gain on assets bought and
vice-versa. Because the effect is to 'hedge' that part of the risk due to
overall market movements this became known as a hedge fund.

------
gojomo
Circle this date in your calendars: an argumentative headline with "gratuitous
editorial spin" from PG himself!

The S&P is down ~38% year-to-date; would it also follow that stocks, stock
markets, or shareholder capitalism "turn out not to work"?

Wouldn't anyone in an S&P index fund rather be in one of these awful, awful
"average" hedge funds? I know I would -- even just for 2008, never mind the
many up years!

------
lemonysnicket
So when does someone cry 'But PG, it's not hacker news!'

------
mhb
Why are these things even called hedge funds? What they do is the opposite of
hedging.

~~~
zandorg
From the LTCM history When Genius Fails, I gather they wait for prices of
equivalent bonds,stocks etc, to converge to the same value.

Okay, so a US treasury bond is equivalent to a UK treasury bond, except it's
off by 0.0005%. So you buy billions/trillions of each and the price converges,
and you make millions.

~~~
mhb
Well, yes. That's what arbitrage is and in what you would _expect_ hedge funds
to engage. Only they do much riskier things than that. Hence my comment.

