
How do hedge funds get away with it? Eight theories - tristanj
http://www.newyorker.com/online/blogs/johncassidy/2014/05/how-hedge-funds-get-away-with-it.html
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30thElement
The second point is actually a point for hedge funds. The S&P 500 went from a
high of 1576 near the end of 2007, to a low of 666 in the beginning of 2009
(October 07 to March 2009, specifically). Commodities had similar losses. If
hedge funds only lost 20% when the general market lost almost 60%, they are a
pretty good hedge against risk.

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shkkmo
It's pretty disingenuous to compare numbers from two different time spans. I
don't know where the authors numbers come from but he says the drop was 20% in
2008.

Your numbers add an additional 6 months during which the S&P 500 dropped
significantly:
[https://www.google.com/finance?q=INDEXSP:.INX](https://www.google.com/finance?q=INDEXSP:.INX)

additionaly, the time period you cite seems hand picked to start at the high
and end at the low.

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30thElement
You're right, the period was "hand picked", but that's because I was looking
at a 5 year graph with the high and low marked, and just used those numbers.
The movement before/after 2008 wasn't the 40 percentage points that would be
needed for the hedge funds to do as poorly as the market, so I didn't bother.

But I just looked the exact numbers up. The S&P 500 opened January 2nd at
1467.97 and closed December 31st at 903.25. A 38.5% loss instead of the 60% I
said, but that's still almost twice the loss of the hedge funds.

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the_watcher
My problem with articles like these can be seen in the title. The best way to
get to an answer of the question I believe he thinks he is asking (Why do
people continue to give money to hedge funds despite evidence that on average,
you are better off with the 60-40 stock/bond mix?) would be to present what
hedge funds are, present the alternatives, and delve into the reasons. Now, he
does most of those things in the piece. The problem is that his original
question was already biased - how do they "get away with it." He assumes that
there is something going on that blinds all who invest in hedge funds, when in
reality, the truth is much closer to this: Those who invest in hedge funds
think they've found the one that outperforms average.

TL;DR - hedge funds are for the more risk-tolerant (I agree with his issues on
pensions and endowments being invested in riskier vehicles, but that's a
separate issue from the question he posed).

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wtmcc
This article considers hedge funds in the aggregate, which seems to me to be a
fallacy. It doesn’t consider variation within a category which we can usefully
select against.

“Money in hedge funds is a bad investment” seems similar to saying “going to
college is a bad investment,” when the value of a college degree is highly
dependent on institution and major. CS at Stanford may be a fabulous
investment, while Folklore/Mythology at U of Phoenix may not be.

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kevinpet
The difference is that past performance is a good predictor of future results
for college education.

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deathflute
Well, the reality is that the top ~5% of hedge funds generate all the returns
and have real alpha. The rest are beta + noise - transaction costs.

Not dissimilar to the way venture returns are distributed. Only the top
startups manage to become big companies and provide a sizable return to their
investors.

So hedge funds get away with it the same way most startups get away with it.
For better or for worse, the investors do not have the ability to accurately
discriminate.

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hkmurakami
Exactly. And the ordinary person (even through an ibank) will not be able to
gain access to the best funds.

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D_Alex
And it would not matter if he/she could, because there is no good way to tell
what the best funds are in prospect.

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johnvschmitt
The lack of transparency explains most of this.

Investors expect the Hedge Funds to have some inside info.

For example, I've heard some hedge funds have "friends" who are staffers for
congressmen. It's quite profitable to know what laws will change before
everyone else does.

The investors may be recognizing that hedge funds are profiting from political
corruption, & choose to look away from the ugliness & pay the fees in order to
get in on the deals.

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pessimizer
This is it. Only insiders win, and people think that they've put their money
with real insiders.

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spikels
Its not just hedge funds. The same could be said for ALL active investment
managers (and even many "index" funds). This has been well know for
decades[1].

Of course people who manage their own money do even worse[2]!

Luckily we have index funds and some of them are well managed (i.e. deliver
what they say at the lowest possible cost).

[1]
[http://www.stanford.edu/~wfsharpe/art/active/active.htm](http://www.stanford.edu/~wfsharpe/art/active/active.htm)

[2]
[http://www.traderslaboratory.com/forums/attachments/30/26024...](http://www.traderslaboratory.com/forums/attachments/30/26024-what-
new-trader-needs-know-about-individual_investor_performance_final.pdf)

~~~
Tloewald
Right, but hedge funds are less transparent and have a greater mystique than
other managed funds right now.

BTW my takeaway from the article is I should diversify more into bonds, and
bond index funds are not as compelling, relative to managed funds, as stock
index funds. So I need to do some research.

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parenthesis
Hedge fund managers are fund managers. In general, fund managers make money in
proportion to the magnitude of funds under their management. This proportion
tends to be bigger for the hedgies than for other fund managers. (Often so-
called `2 and 20' fees are charged: 2% of funds under management and 20% of
investment gain (often subject to a high water mark) per annum.)

All else being equal, good performance leads to inflows and poor performance
to outflows. However, many institutional investors have been increasing their
hedge fund allocations despite the hedge fund world underperforming typical
simple passive strategies over the past five years. This could be in the hope
that the hedgies will outperform during the next bear market / downturn /
financial crisis; after all, the whole point of hedge funds is supposed to be
to achieve reasonable positive absolute returns come what may.

~~~
trhway
through hedgies the institutionals get access to such investments as late
stages financing rounds in the Valley. This is btw what feeds current
(presumably last, at least until new huge money come in) stage of the bubble
we're right now in.

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the_watcher
Hedge funds get away with it because no one who invests in a hedge fund is
investing in the average hedge fund. The average hedge fund performs about as
well as the S&P 500. Ok. However, I doubt you could find anyone with money in
a hedge fund (knowingly, at least - the investment of endowments and pensions
are a different issue than the one I am addressing) who would claim to have
invested in one with "average" performance. The upside of hedge funds is much
higher than safer investment vehicles. That's why people keep using them. The
issue is the same one that plagues law students going to schools with bad
employment outcomes - people are completely capable of understanding likely
outcomes and expected performance. They are even better at believing that they
are the positive outlier.

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amcaskill
Yale's endowment report offers a straightforward discussion on why they invest
heavily in hedge funds, private equity, venture capital etc.

TL/DR: it's the first three reasons from this article.

[http://investments.yale.edu/images/documents/Yale_Endowment_...](http://investments.yale.edu/images/documents/Yale_Endowment_13.pdf)

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jgalt212
Here's my theory: 2/20\. Their outrageous fees give the managers so much money
that they can buy off all detractors, and pay others who are perhaps on the
fence to push their product.

At this point, there is so much money invested in hedge funds ($2.1T), I'd
argue there is no alpha left to harvest. Any money invested in HFs at this
point is just a pure wealth transfer.

I'd also stipulate that the perceived lower risk of hedge funds could somewhat
in part be attributed by HF's reluctance to mark down their investments to
market clearing levels in 2008. Index Funds and Mutual Funds who mostly
traffic in securities that have official closing prices have no leeway to
understate the true volatility of their investments.

I think this volatility understatement problem is probably a bigger problem
then survivorship bias from the terms of an investor making asset allocation
decisions.

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im3w1l
They main idea of a hedgefund, as I've understood it is to generate
_uncorrelated_ returns. The idea is that by owning lots of uncorrelated assets
you will have less volatility for the same return. Hence I think a better
comparison than 60stock/40bond vs 100%hedge could be for example
60stock/30bond/10hedge against 60stock/40bond.

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tpeng
The most glaring error in this article is that the author is talking about the
hedge fund industry as a whole, but he uses the S&P 500 as a benchmark. Hedge
funds that don't invest in equities are not, and should not be, benchmarked to
the S&P 500.

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shkkmo
1) > Hedge funds that don't invest in equities are not, and should not be,
benchmarked to the S&P 500

Why not?

2) So what DO you benchmark the industry as a whole against?

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QuantumChaos
In an efficient market, we would expect the after-fees returns of hedge funds
to be no better or worse than any other asset class (adjusting for risk, beta,
etc.)

So there really is no puzzle here.

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CapitalistCartr
This isn't hard to understand. As P. T. Barnum supposedly* once said, "There's
a sucker born every minute".

*[http://en.wikipedia.org/wiki/There%27s_a_sucker_born_every_m...](http://en.wikipedia.org/wiki/There%27s_a_sucker_born_every_minute)

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atmosx
After 3 decades of deregulation[1] and the 2008 financial crisis which caused
a world-wide meltdown... Still asking these kind of questions is naive, stupid
but most of all dangerous[2].

[1]
[http://en.wikipedia.org/wiki/Freefall:_America,_Free_Markets...](http://en.wikipedia.org/wiki/Freefall:_America,_Free_Markets,_and_the_Sinking_of_the_World_Economy#Deregulation)

[2]
[http://www.nytimes.com/2009/07/17/opinion/17krugman.html](http://www.nytimes.com/2009/07/17/opinion/17krugman.html)

