The overall investment experience for hedge fund investors has been so abysmal that most industry professionals are sensibly keeping their heads down. There are great hedge funds to be sure, and happy clients, but the data shows indisputably that these are not the norm. Hedge fund managers themselves of course aren’t responsible for the industry, only their own fund. So they have no reason to comment or even care about my book – and quite right too, because it’s not directed at them anyway, but at their clients. Hedge fund managers don’t need my help.
However, Mr. Andrew Baker is CEO of the Alternative Investment Management Association (AIMA), whose website says it is the,”global representative of the hedge fund industry”. It’s Mr. Baker’s job to promote hedge funds as a good investment, and he embraces the mantle, as he showed in a letter last August to the Financial Times in which he chastised writer Jonathan Davis for promoting “hoary old myths” about hedge funds. Mr. Baker goes on to note that, “Far from being disappointing, hedge fund performance has been impressive. During 1999-2010, the major hedge fund indices achieved overall returns (net of fees) of more than 8 per cent per annum.” As Mr. Baker may not have known then, but may learn if he reads my book, the good years for investors were when the industry was small. 8% per annum may sound good, but it’s far higher than what the average investor earned. The Absolute Return business has failed to deliver investors an Absolute Return but has instead retained at least 84% of the trading profits earned on client capital during this time; their money would have been better off in treasury bills. I wish Mr. Baker’s letter had been published in time to make it into my book.
From my book, with apologies to Sir Winston Churchill whose speech following the Battle of Britain in 1940 inspired this line. Fees have, without doubt been part of the problem for hedge fund investors. The financial press is picking up the story and some of the articles are linked on the book’s website. Meanwhile, sales have now reached the top 0.1% of books available on Amazon both in the U.S. and the UK.
I’ll be discussing my book.
You’d think it would be hard to find much humorous in the kind of year hedge funds have had – down 8.5% for the year in their second worst performance in history. But there can be, depending on your perspective.
When I summarize my book, The Hedge Fund Mirage with the simple explanation that all the money ever invested in hedge funds would have been better off in treasury bills, I elicit a variety of responses. Rather like the concentric circles emanating from the point at which a tossed pebble hits the water, how people feel about this depends on how close they are to impact.
People I know in the hedge fund business almost invariably note that they’re not surprised. They may not have done the Math as I have to actually calculate the IRR of the industry, or examined the impact of fees on returns, but they do at some visceral level comprehend that it’s been a better ride for the managers of hedge funds than their clients. One individual who knows the numbers as well as most responded, “OMG, you’ve written THAT book?” But generally, the industry is not shocked by the result. That itself may be shocking.
One step farther removed are people who one might classify as financially sophisticated but not directly involved in hedge funds. This group includes professionals such as doctors, lawyers, accountants and other successful business people. They may serve on non-profit boards or investment committees, are in many cases wealthy enough to qualify as hedge fund clients and are reasonably in touch with the investment landscape. Their reaction is the most understandable, and a combination of shock and disappointment typically follow. They may be thinking back to investment committee meetings at which a consultant has promoted hedge funds for their non-profit’s investment portfolio. Or they may be hedge fund clients themselves through some helpful private bank. But they are genuinely dismayed at the result.
But most interesting is the response from those farthest from the center. Call them the 99%. Regular people that you might run into at Starbucks in the morning. Teachers, nurses, local town employees, individuals whose only knowledge about hedge funds is drawn from what they see on TV and who can only dream of the wealth that their qualified clients claim. If this group has any savings they’re largely in a 401K or other qualified retirement plan, and hedge funds are that mysterious but unbelievably lucrative area of Wall Street that’s way out of reach. These people have never met a hedge fund manager. And how do they feel about learning that investors should have been in treasury bills? They laugh. Without exception. The 1% (which is after all where hedge fund clients are to be found) may not pay enough in taxes and have enjoyed most of the benefits of economic growth over the past 30 years, but this is one place where the 99% have probably done better than the 1%.
Even if the un-invested spent their money rather than saving it, they probably got more out of it than the less-than-treasury-bills return earned by those closer to the center. It’s a satisfying feeling. Chuckles, smiles, laughter and guffaws quickly follow as the realization dawns that those with the fewest financial problems made at least one wrong move. In one arena, the 99% have outwitted the 1%. Maybe not intentionally, but that doesn’t matter. As Basil Fawlty crowed in one memorable episode (“Communications Problems”) “…for once in my life I’m actually ahead.” Of course, he wasn’t as became clear moments later, but that’s another story. For 99% (and I must admit that I probably belong in the 1%) hedge funds can be funny, and everyone deserves a good laugh from time to time.
My book, The Hedge Fund Mirage, is finally in print and making its way up the Amazon Best Sellers list (currently in the top 3%). The hedge fund industry has co-operated in its launch by delivering the second worst year in history. Not all hedge funds are bad though, and since some of the most talented managers will always be found running hedge funds it’s worth figuring out how to be a hedge fund investor in the good ones, on fair economic terms so that the steady transfer of wealth from clients to managers isn’t perpetuated. In my book I’ve tried to show hedge fund investors how they might do that.
I spent a most enjoyable lunchtime at a roundtable sponsored by the Centre for the Study of Financial Innovation (CSFI). The topic of debate was my book, and more specifically my assertions that hedge fund investors have not done very well. It was a spirited and informed debate, with lively interchange among the participants. Hopefully I left the audience with a few thought-provoking ideas about hedge funds and the contrasting fortunes of the managers compared with their clients. I should also thank the CSFI organizers for making the event possible. It was very well organized and the room was filled with well-qualified, articulate finance professionals (hopefully my presence didn’t render that less true).
I was also on Bloomberg TV this morning.
I have arrived in London and am therefore physically closer to the Eurozone crisis than normal. Tomorrow I’ll be spending a lot of time promoting my book – Bloomberg at 7am, a roundtable debate at the Center for the Study of Financial Innovation over lunch and Jeff Randall on Sky in the evening. Hedge funds are having their second worst year in history. Even a skeptic like me didn’t expect the industry to deliver such a poor year.
Many years ago, when hedge funds managed far fewer assets and returns were generally good, they were described as Absolute Return strategies. Perhaps the best industry magazine covering the sector is called AR Magazine. An Absolute Return suggests that it should be positive in most circumstances, which to most people sounds like an attractive proposition. But in 2008 hedge funds delivered a very definitely Not Absolute Return by losing 23% (as defined by the HFRX Global Hedge Fund Index) and thoughtful industry promoters concluded that a different adjective was needed to characterize their performance. Some settled on Uncorrelated Returns, suggesting that while they could no longer deliver consistently profitable results, they could promise that whatever they delivered would be uncorrelated with traditional assets. This can also be a worthy objective, assuming that over an appropriately long period of time the returns are positive. However, uncorrelated returns are not as easy to generate as you might think, and Felix Salmon noted just the other day that hedge fund industry returns were in fact becoming more correlated with equities.
And yet, CNBC reported on Wednesday that hedge funds were “dumping stocks” and hoping for a better year next year. Their report noted that hedge fund exposures to equities are the lowest since 2008. And so they ought to be. Because the HFRX is down 8.5% for the year, on track for its second worst year in history (handily eclipsed by 2008). Through November, the S&P500 (including dividends) is +1.1% for the year; the Dow Jones Corporate Bond Index is +6%. Clearly using the moniker “Absolute Return” more sparingly was a smart move. 2011 will mark the 9th consecutive year in which a 60/40 split between stocks and bonds has outperformed hedge funds. But the (sort of) good news is that hedge funds have shown that they can deliver uncorrelated returns. In fact, for many hedge fund clients they’ll be hard pressed to find other segments of their portfolio that have done as badly. There’s been a great deal of manic buying and selling, of risk on followed by risk off, of deleveraging and releveraging, and it looks as if for the average investor it’s burned up time, fees and capital.
If you’re not a hedge fund investor, you’ve probably done better in 2011 than those who are. Hedge funds are making my book appear more insightful than I might have hoped.