Source:
https://scmp.com/comment/insight-opinion/article/2150535/dear-hedge-fund-investors-youre-probably-not-next-george
Comment/ Opinion

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

George Soros famously (or infamously) made a killing shorting the British pound on “Black Wednesday” in 1992, which resulted in Britain’s exit from the European Exchange Rate Mechanism. Photo: AFP

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.

You know their names – people like George Soros, who is credited (or should that be vilified?) for breaking the Bank of England in 1992 with a trade that made US$1 billion for him and was the killer blow to Britain’s membership of the European Exchange Rate Mechanism.

Then there’s John Paulson, who made a massive bet against the subprime housing market in the United States in 2007, and later decided to prolong the mayhem he caused by becoming a key economic adviser to Donald Trump’s 2016 presidential campaign.

The eye-watering sums of money earned by people like Soros and Paulson tend to be remembered rather better than the fact that both men have also made pretty impressive losses, but this is the way of the investment world, where success is recalled more readily than failure.

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.

Not only do they yearn to clamber aboard but they are also prepared to pay way over the odds for these clever people to look after their money. Sometimes it works, particularly when the markets are in the doldrums and hedge funds, betting on a downturn, perform way better than the average investment relying on markets rising.

Yet, here we are in 2018, almost at the end of two decades that saw a spectacular market fall in 2008 and one of the longest bull runs in history, and hedge funds have been languishing.

Bearing in mind that the bull market has been running for nine years, why have hedge fund managers not been able to adjust strategies?

The results of this failure are there for all to see. The HFRX global hedge fund index shows that, since March 2009, these fund managers have underperformed the S&P 500 Index by 70 per cent.

Street signs are seen outside the New York Stock Exchange in February 2009, four months before the US exited the recession brought on by the subprime mortgage crisis. Hedge funds underperformed benchmarks in 2008 as the crisis took shape, and have continually underperformed the S&P 500 index since early 2009. Photo: AFP
Street signs are seen outside the New York Stock Exchange in February 2009, four months before the US exited the recession brought on by the subprime mortgage crisis. Hedge funds underperformed benchmarks in 2008 as the crisis took shape, and have continually underperformed the S&P 500 index since early 2009. Photo: AFP

Moreover, and this is really shocking, in 2008, when hedge funds should have been delivering maximum profits to their investors, they actually managed to underperform benchmarks by 6 percentage points, according to CEM, a Canadian-based investment consultancy.

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.

Hedge funds are managing more than US$3 trillion at present. Photo: Reuters
Hedge funds are managing more than US$3 trillion at present. Photo: Reuters

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