Dear hedge fund investors: you’re probably not the next George Soros
Stephen Vines says the reason hedge fund managers’ profits continually grow, even as the hedge funds themselves consistently fail to deliver, is that investors tend only to remember the highly publicised cases of ‘money gods’ who netted huge sums in unusual circumstances
Here’s a thing: hedge fund managers’ earnings are soaring while hedge fund performance is heading south; indeed they’ve been delivering pretty dismal returns for at least 16 years.
We’ll get back to figures soon but let’s start with the obvious question of why this perverse correlation exists, because it makes no sense.
Hedge fund managers, a group generally untroubled by the demands of modesty, have a number of superstars in their ranks and investors are attracted to them like fleas to a dog.
Investors, focusing on the positive, yearn for a piece of the action. They are mesmerised by these money gods, whose stature is enhanced by the very complexity of hedged investments, which most investors don’t fully understand, but it seems to confirm just how clever they are and intensifies their desire to scramble aboard the money gods’ ships.
Bearing in mind that the bull market has been running for nine years, why have hedge fund managers not been able to adjust strategies?
CEM also looked at the period 2000 to 2016, and found that the biggest hedge funds underperformed most benchmarks by some 127 basis points after taking their fees into consideration.
And here’s the rub, because their returns before fees actually outperformed these benchmarks by 145 basis points, a figure that plunged in terms of investors’ real returns because these funds charge very large sums for their “expertise”.
Yet, while hedge fund investors suffered miserable returns, hedge fund managers earned more. The annual Institutional Investor magazine survey of their earnings shows that the 25 highest earners took home an average of US$615 million last year, making a collective total of US$15.4 billion, up from US$11 billion in 2016. Top of the list for the third straight year is James Simons, of Renaissance Technologies, with total earnings of US$1.7 billion in 2017.
These eye-watering sums include money made on their own investments in these funds.
Pity the poor punters who trusted these investment magicians with their money and would be more than grateful to have enjoyed even a fraction of what they took home.
Despite disappointment and some impressive withdrawals from hedge funds in recent years, they still collectively have something like US$3.2 trillion under management and so remain very much in the game.
Why? Could it be that past glory lingers and maintains the customer base? Maybe the very complexity of how some funds operate is sufficient to persuade investors that these managers must be really smart or maybe, considering how much institutional money is vested in these funds, they simply form part of a massive diversification strategy which somehow seems incomplete without a big dose of hedging?
Given that simple fund-tracking can offer better returns at a fraction of the management cost, why does any sane person even consider heading off to the plush premises of hedge fund managers? The answer is the same as it always is in the world of investment, namely the belief that somehow it’s possible to beat the market.
Good luck, suckers.
Stephen Vines runs companies in the food sector and moonlights as a journalist and a broadcaster