
84% of the investment gains from hedge fund went to the managers - Dobbs
https://plus.google.com/107033731246200681024/posts/7VmpGHzmY3R
======
DevX101
Warren Buffet made a bet that a market index (S&P500) would outperform hedge
funds. So far, he seems to be winning the bet.

<http://longbets.org/362/>

As the hedge fund market grows by 10x, its all but certain returns will
decline. The economy isn't a zero sum game but when investment funds grow
faster than investment opportunities, logic dictates that median performance
will fall and there will be more absolute losers.

Furthermore, picking a hedge fund manager becomes an exercise in futility as
the number of managers increase. The pension fund administrator can pick the 1
in 10 stocks he believes will return 15% per annum or he can pick the 1 in 20
hedge fund managers he believes will return 15% per annum. (The numbers here
are made up but I hope you see my point).

Either way, the pension fund administrator will need to research on where to
park money, but I'd argue the variables to predict future performance are much
more transparent with stocks than with hedge funds. All the administrator has
done is transformed the problem of picking a winning stock, to picking a
winning hedge fund. The only difference being the hedge fund is guaranteed to
take a cut of your money.

~~~
suking
There are advisors and fund of funds just to hedge your bet on hedge funds -
and like you said - it's only going to get harder. Picking a hedge fund is
going to be like picking the next hot pharma company.

~~~
xefer
Well that's more or less what tese things are. Instead of investing in a
startup, your effectively betting that a group of money managers will hit pay-
dirt with a unique investment strategy. For te most part only people with so
much money they can afford to risk a pile can even play

------
OstiaAntica
Even worse, hedge fund managers somehow get their income classified as
"capital gains" and only pay the 15% rate on their earned income, even though
they never had any cash equity at risk. It is a massive subsidy to the
industry and it is grossly unfair to other taxpaying Americans.

I have similar sweat equity in my tech company, and have to pay income tax
rates and payroll taxes on my earnings.

~~~
guelo
And when there was some noise a couple years ago about changing that tax
loophole the idea was immediately squashed by congress and it died a quiet
death. Almost as if congress does Wall Street's bidding to the detriment of
the overall national interest. Almost.

~~~
tmh88j
That "loophole" you're talking about is known as carried interest. Carried
interest exists for a good reason (at least to my understanding); so that
partners can with less capital can build sweat equity. Sure there are people
who take advantage of it, but it does serve a purpose (taxes more so than
retaining their profits). I'm not saying there aren't plenty of greedy hedge
fund managers, but understanding why it exists will at least help form a solid
opinion.

>The arguments for the carried interest are fairly compelling: without it, the
partners who contributed ideas and talent end up being taxed much more heavily
on their earnings than partners who contributed financial assets. This is not
only sort of unfair, and impedes the ability of talented people with few
financial resources to move into the moneyed class, but also might have
implications for economic growth: if your gains are going to be taxed at
ordinary income rates, why quit that safe job and risk all on an untried
venture?

[http://www.theatlantic.com/business/archive/2011/08/thinking...](http://www.theatlantic.com/business/archive/2011/08/thinking-
about-taxes/243651/)

------
siavosh
There's at least one big fallacy in this post: "This is a tiny fraction of the
1% fleecing the rest of the 1%."

This is dangerously inaccurate. A significant portion of hedge fund assets are
from institutions not wealthy individuals. This includes government assets
(from local to federal), college endowments, pension funds etc.

If the analysis is correct, this is a tiny part of the 1% fleecing all of us,
and your parents too.

~~~
guelo
I don't know enough to be sure one way or another but when Bernie Maddof's
fund collapsed it did seem like it was mostly just rich people who lost money.
Also it seemed like clients were obtained via personal relationships, not any
kind of market exchanges. But I don't know if that fund was typical or not.

~~~
2arrs2ells
Quite a few nonprofits and foundations had money invested with Maddof, and he
was a rather sketchy money manager.

Many (most?) universities have some funds invested with hedge funds (as well
as VC funds and PE funds).

~~~
wallflower
You can make the argument that Harvard is an unregulated hedge fund.

"I say get rid of exemptions on profits while keeping the charitable deduction
for donors. Why should Harvard be tax-exempt on the dividends it receives from
Microsoft or IBM stock, when everyone else is taxed on that dividend?"

"So, in my mind, Harvard is a hedge fund that has a relatively small, money-
losing education business on the side. I can see a justification for an
endowment in a world of uncertainty when there are “bankruptcy costs”
associated with the failure of a non-profit. However, large endowments are
disturbing and are possibly evidence that a non-profit has not followed a zero
or negative IRR strategy."

Excerpts from the comments, not from the article

[http://marginalrevolution.com/marginalrevolution/2008/05/wha...](http://marginalrevolution.com/marginalrevolution/2008/05/what-
should-be.html)

------
sakai
It's worth pointing out that the FT's 84% figure is NOT correct, though that
actually further reinforces the point that fund managers are fleecing their
investors.

While the funds collectively realized $449bn in investment gains and paid out
$379bn in fees to managers, the hedge funds earned a significant portion of
these fees without making their clients a penny. Rather a fraction of the
$379bn is a share of the gains fund managers made their clients, while the
(likely very large) remainder of the $449 is derived from straight management
fees (typically 2% of invested assets).

------
JumpCrisscross
There is a problem with this analysis - the 449 figure is capital paid out,
not gains. The worst funds have their capital withdrawn at the fastest rates;
investors in the best funds tend to keep their capital put.

By Lack's metric, which ignores un-realised gains, Warren Buffett's Berkshire
Hathaway, which hasn't paid a dividend but pays salaries to its "managers" is
a ruddy failure of an investment institution.

It should also be noted that not all cash taken by the fund manager as
compensation goes straight into the mamagers' pockets - there are staff,
Bloomberg terminals, and office space to be paid for. At smaller funds, the 2%
asset fee can sometimes barely cover that.

The FT author likens hedge fund statistics to a "statistical minefield".
Rather helps if you don't lay the mine you blow up.

~~~
sakai
The article does call them gains, but if it's truly only the capital paid out
this is a good point. More likely, these numbers are abysmal because of the
poor performance of equities over the selected period (1998-2010) and
consequently the fact that investors have paid a lot in 2% management fees and
received little upside in the way of gains.

~~~
JumpCrisscross
We also have to marry this to the reality that most hedge fund managers have
around 2/3 of their net worth in their funds.

When markets crash you see more redemptions from bad funds than good funds; by
only observing redemptions the good are ignored and bad are counted. Since
those funds are still charging asset fees, the numbers are probably distorted
towards 100% the worse the preceding period's equity market performance.

Are hedge fund structures in need of reform? Probably. Do we need to warp and
mis-represent statistics to accomplish this? No.

Bottom line is that saying that the ratio of cash out to operators to cash out
gross is 84% is meaningless given that it has survival bias built in - in the
inverse. Bad funds who dissolve and result in massive outflows are over-
represented. Those that succeed and hold capital, e.g. Berlshire Hathaway and
Renaissance'a Medallion Fund, are ignored.

I'm just imploring the HN community to remain objective, even when bad
evidence seems to agree with our pre-conceived notions.

------
solutionyogi
Something does not add up.

The author is claiming that between 1998 and 2010, managers earned between 379
billion in fees.

Generally, hedge funds operate on 2/20 model i.e. 2% of the assets as the
management fee + 20% of the profits. [Obviously these varies across hedge fund
but for now, let's assume everyone follows this model.]

E.g. If I give a hedge fund 100MM, they would charge me 2MM to manage it.
Let's say they generate 10MM in profit. They will take 20% of that 10MM as
performance fee. So to get 8MM, I will be paying them 2MM + 2M = 4MM which is
40% of the profits.

Now that's clear, let's run this logic on author's numbers.

Let's assume equal distribution which means that hedge fund earned around 30
billion in fees per year. (379 billion divided by 13 years between 1998 and
2010). If 30 billion is 2% of the assets, it means that they were managing
1500 billion dollars. The biggest hedge fund in the world, Bridgewater
Associates, manages 125 billion dollars. There is no way other hedge funds can
account for the remaining money.

~~~
D_Alex
Sooo... what happens if the returns are negative? Does the fund manager cop
20% of the loss?

What happens if the gross return is 2.5%? Does the fund manager still get
everything (2% fee plus 20% of the 2.5% gross)...?

Clearly if the returns are between 0 and 2% the fund manager wins and the
investor loses. Seems to be open to all kinds of gaming of the system.

~~~
Gaussian
This is exactly the rub. Managers take no haircut when the fund gets hammered.
It is true that most managers won't take a profit on investor's money until
they return to the "high water mark" of how much $$$ that investor originally
put into the fund, but often times when a fund loses too much money, the
manager simply closes it and opens another, therefore dodging the high water
mark requirements.

But honestly, if rich people can't figure out that their fund manager is
ripping them off, then to hell with them. Fund managers, at least, prey on
people who are already rich. Better than a lot of other sleazes who take
advantage of the undereducated and poor. I'm not saying it's right, I'm just
saying that if you have enough money to write John Paulson a check, then you
should know what you're doing. I can't say the same for an old woman in a bad
neighborhood who was talked into refinancing her house of 50 years so she
could take out cash to buy a conversion van. The people who preyed on her are
far worse, in my mind, than your average fund manager who does nothing of
virtue for his clients.

~~~
ams6110
People (and actually it's institutions, mostly) who invest in hedge funds are
sophisticated investors. They know full well what the managers are being paid
and presumably feel they are worth it.

~~~
hessenwolf
Ha ha. Good one. What are you basing this on?

~~~
ams6110
The fact that they keep their money with the manager? Sure there might be a
few people who don't know what they are doing (lottery winners?) but if you
have enough money to buy into a hedge fund, you more than likely are paying
attention.

~~~
hessenwolf
I don't see why you think A applies B at all here. I have worked both in
institutional investment and in a hedge fund, and it's pretty fucking hard to
read a term sheet for anybody.

------
mbesto
I have such a hard time understand investing on this scale. Who the heck are
these investors that continue to put money in these funds? Are there really
that many wealthy people/organizations that are duped into the fallacy of
hedge fund returns?

This also reminds me of the idiots who paid into the Groupon investment just
so they could pay off the original investors (who happen to be largely the
Groupon CEO): [http://www.bloomberg.com/news/2010-12-30/groupon-has-
raised-...](http://www.bloomberg.com/news/2010-12-30/groupon-has-
raised-500-million-of-950-million-it-sought-in-funding-round.html)

When a market is littered with this much "loss" doesn't it eventually adjust?

~~~
jcampbell1
_This also reminds me of the idiots who paid into the Groupon investment..._

You link to an article where they invested at a $4.5B valuation, and now the
company is worth $11.5B. It seems your hindsight isn't 20/20, or you think
250% returns in 12 months is low.

~~~
ceejayoz
> You link to an article where they invested at a $4.5B valuation, and now the
> company is worth $11.5B.

Can they sell their $1B without the stock tanking, though?

------
kevinrpope
It seems that this sensational headline (and the subsequent article) leaves
out a main point as to why this would be happening: performance fees paid
prior to 2008.

Assuming the 2/20 fee structure, HFs would have taken 10 years of 20% fees on
their performance before 2008 knocked out (according to the article) all of
the returns for the previous 10 years. That would leave the investors back at
0, minus 10 years of 20% performance fees and 2% management fees. Given the
time frame, I'm surprised the fees aren't greater than the realized gains.

~~~
yummyfajitas
It's also worth noting that many funds make performance feeds contingent on
long term returns.

So for the funds in question, if 2008 knocked out all their returns, they
can't collect performance fees again until they have fully recovered from
2008. I.e., no more performance fees until the fund recovers from 2008.

~~~
DevX101
The managers are more likely to close the fund, open up a new fund under a new
name and start the game over again.

From this morning:

[http://darien.patch.com/articles/collapse-of-darien-hedge-
fu...](http://darien.patch.com/articles/collapse-of-darien-hedge-fund-
threatens-kentucky-state-pensions)

[http://www.sfgate.com/cgi-
bin/article.cgi?f=/g/a/2012/01/03/...](http://www.sfgate.com/cgi-
bin/article.cgi?f=/g/a/2012/01/03/bloomberg_articlesLX89WS6K50YJ.DTL)

------
adamtmca
If anyone is interested, "Inside the House of Money" is a pretty enjoyable
book about "global macro" hedge funds in the mid 2000's. It's just a series of
interviews with hedge fund managers about their careers, their favourite
trades and how they run their funds.

The interviews all take place prior to the financial crisis and it's neat to
see how they were thinking about the economy. It ranges from "we're in
trouble" to "I'm confused about what is driving the CDS market so I am on the
sidelines."

As for the story, I am totally apathetic. If you invest in a hedge fund you
are well aware of the fee structure going in and you are a sophisticated
investor. Ultimately these guys only make money if their clients make money.

------
zallarak
If the markets [or the managers] performed better, a higher proportion of
investment gains would go to the investor.

As mentioned in this thread, fund managers are compensated based on a % of AUM
and a % of profit, such as 2% and 20%. When the fund loses money, investors
are the only ones that experience a net loss (the managers still net a % of
AUM, or nothing at worst). If managers end up not losing money, the investor
mathematically keeps a larger proportion of the gains.

Also, when you invest in a fund, the idea is you are trusting someone else
with your money. This article does not imply managers as shareholders. With
this in mind, it does indeed make sense that in times of low performance and
frequent losses that the people with no way to lose money end up keeping a
greater proportion of earnings.

EDIT: This might seem obvious, but its worth mentioning that in times of very
good fund performance, the investors will keep an increasingly greater
proportion of earnings.

~~~
ams6110
When it comes to hedge funds, the managers typically are heavily invested in
the funds themselves.

~~~
zallarak
Yep, but proportionally the amount is trivial.

------
webnographer
I am an expert coin tosser :) If you have 1000 people tossing coins some of
them will become experts at tossing heads every time.

~~~
mahmud
Greetings fellow disciple of Taleb! :-)

------
mikepmalai
I'd be interested to see the data and methodology used.

1998 to 2010 was a wonky period in the markets with both the tech and leverage
bubble/bust, making any sort of estimate on performance/fees/assets tough.

------
Tycho
I don't understand what the article is talking about. Hedge funds
traditionally take 20% of the profits from their investments. They also pocket
2% of the money that investors put into the fund (and 2% of it again when they
withdraw), but I don't see why this would be classed as 'investment gains.'
It's just more money they've been given to manage.

~~~
JumpCrisscross
I posted a more complete thought as an independent comment, but essentially,
by focussing on redemptions Lack'a analysis ignores un-realised gains. By this
logic, Berkshire Hathaway has paid out less in dividends (zero) than
accumulates compensation to its staff (since we are noting all cash receive by
the fund as manager compensation, research and office space be damned).

------
mynameishere
Yeah, and it's trivially proven. To the extent that hedgy X captures alpha,
hedgy Y will not, and since they are both representing the same class of rich
suckers, the only money gotten is the rake, aka, the 2-and-20 fee structure:
mathematically the only people who can win are the funds themselves. Nothing
complicated about it.

------
forensic
A lot of reasonable, sensible, intelligent, math & business oriented people
saw this coming. I surely did and I'm not a financial professional. Financial
products are basically snake oil there to enrich the salesmen at the expense
of the clients. The clients eat the losses, the salesmen eat the gains.

The stock market in general is a rigged game there to enrich insiders and
salesmen.

The reason financial products proliferate is because a sucker is born every
minute and most people are too unimaginative to see alternative avenues of
investment.

It's not a productive industry. It's snake oil at best and more realistically
is just a giant parasite on the economy.

------
budley
There is a glut of hedge funds, the best large ones are usually closed to new
investors. In a year where many struggled of course fees v return looks bad.
2% of assets and 20% of gains is a steep price but it is cheap when you get
one of the best. Pension funds don't do a good job of selecting managers and
every man and his dog has opened one just to collect 2&20 rent on the money.
Very few managers have an edge and it can be impossible to tell which ones do.
All statistics on hedge funds are of limited value as the samples are
incomplete and skewed - it is an information game after all.

------
wtvanhest
When I first saw this post my initial reaction was... The data must be wrong,
it doesn't make sense!

I thought about it, and thought about it, then I realized it makes perfect
sense.

Hedge funds as an asset class should net to zero. Meaning, there should be
zero profits on average from Hedge Funds. Since hedge funds hedge, meaning
they supposedly eliminate the effect of market movements, the aggregate of all
of them should be zero.

Overtime, the bad managers loose their clients money and shutter and the good
managers make billions.

Mutual funds should net to inflation.

Anything above zero for hedge funds and inflation for mutual funds represents
alpha. (alpha is the additional return the manager returns).

It makes sense that if the industry is returning any profitability to their
investors they should be paying a fee. If you pick the right hedge fund
manager, you should make excellent returns. Picking the wrong manager results
in you taking gigantic losses.

Even the best managers only make 20%+/- in addition to a carrying fee. But,
the loosing managers suck the other profits out in carrying fees and losses.

I'm not sticking up for hedge fund managers, but I think it is important to
note that it makes sense that 87% "of profits" go to managers after you take
out the losses and lost fees on shuttered funds.

Winning funds still only take 20%ish of profits.

~~~
pyoung
"Mutual funds should net to inflation."

Are you forgetting to include economic growth in your analysis? Historical
long term returns of the major indexes are in the 10% range (ballpark
approx.), much higher than inflation, which I think was in the 2-3% range
(also ballpark).

~~~
wtvanhest
You have to assume going forward there will be economic growth. It is a
perfectly fair assumption, but not a fact. And, I will certainly not argue
with that assumption. (although there are a lot of people that may)

Hedge funds should still net to zero though. Which is much more important for
this discussion.

-I'd be interested in hearing what others think, maybe I'm off on my assumption that hedge funds should net to zero, or maybe I'm missing something else.

~~~
JumpCrisscross
Market participants should net to beta; hedge funds, as a subset of market
participants, have no requirement to net to anything. Likewise for mutual
funds.

~~~
wtvanhest
Hedge funds eliminate beta using the hedge. Whether they should meet market
returns is a conversation institutional asset managers would have with their
clients, but in practice, the aggregate of all of them should net to zero.

~~~
JumpCrisscross
In practice all of them should net to zero conditional upon them being
perfectly beta hedged and having zero net alpha. This is very, very, very
rarely the practical case.

If you had moderated your comment with "in theory" instead of "in practice",
then you would be more right (since they would then converge at the risk-free
rate, not zero).

------
ericdykstra
Theoretically, hedge fund managers should make close to 100% of the gains over
the market rate in fees. Otherwise, why would anyone invest in anything other
than those funds if they're so much better than the market?

------
tlb
Fair enough: the managers did all the work and had all the brains. Investors
in hedge funds were just hoping to get something for nothing.

------
thrill
It's interesting to me that the people who rant about hedge funds ignore that
participation in them is entirely voluntary and even restricted to the wealthy
few.

~~~
DevX101
The biggest source of hedge fund money are pensions. I'm quite certain the
workers didn't volunteer to put their money into hedge funds.

~~~
Tycho
Are you sure about that? Isn't that mutual funds?

~~~
Tsagadai
Completely sure. My Australian superannuation/pension was heavily tied up with
various hedgefunds and it lost about 50% of its value in 2008. I can't tell
them how to spend my money and I can only change between a very similar set of
funds. Many pensions around the world are in similar arrangements with
hedgefunds and investment banks.

~~~
benjoffe
You can put your super into a huge variety of places, or even run your own
fund. Iirc there are about half a million or so such private 'funds' in
Australia.

~~~
mahmud
CHORUS 100x

 _~From big things, little things grow~_

