Hedge Funds

One of the supposed benefits of investing in a Hedge Fund, is the opportunity to make money in both up and down markets.  This goal is appealing to two types of investors.  First, those who do not have the discipline to stick with a “buy and hold” strategy and secondly, it’s alluring to those who believe in “magic.”

With Hedge Funds, transparency is limited, but this lack of transparency is widely accepted by Hedge Fund investors.  Perhaps it’s because it’s hard to believe in “magic” if the data shows that there is no “magic.”  There is however, enough data to show that the collective performance of hedge funds over the past 10 years, falls short of market rates of return that are easily earned with index funds and other passive strategies.

The standard pricing structure of a Hedge Fund, that is 2% per annum, plus 20% of any gain, seems to be acceptable to those using Hedge Funds.  Do the math:  An investment of $1 billion in a Fund that earned 10% would yield a fee of $40 million.  It’s absolutely ludicrous.  But in spite of this fee structure, the Hedge Fund industry continues to grow, as does the wealth of the Hedge Fund managers.  It is not unusual for a successful Hedge Fund manager to take home over a billion dollars in one year.

So are these Hedge Fund billionaires bad guys?  Not really, there are just very good at moving other people’s money into their own pocket.  And who are these “other people?”  Hedge Fund investors fall into three groups:  Wealthy individuals, Pension Plan sponsors, and those managing University Endowments.

It may be foolish to invest in Hedge Funds but wealthy investors can do whatever they like.  After all, it is their money.  But the last two, Pension Plan sponsors and Endowment committees, are managing “other peoples money.”  The money in Pension Plans belongs to current and former employees, not those making investment decisions, and if Endowment Funds underperform, students and others will be asked to make up the difference.

My former colleague, Rex Sinquefield, once said that Hedge Funds are “Mutual Funds for stupid people.”  That’s a bit harsh, but perhaps Pension Plan sponsors and members of the Investment Committee of Endowment Funds are not stupid, they just fail to understand and/or they refuse to accept the Fiduciary responsibility they have when investing other people’s money.  It may not be their money but it must be quite an ego trip to have control over how the money is invested.

3 Comments

Filed under Advisors, Investments, Investors

3 responses to “Hedge Funds

  1. Joe

    Correction, Rex called them “mutual funds for idiots.”

  2. Mark Hebner

    Hey Dan, can I post this on IFA.com with you as a guest author? Hope all is well, mark

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  3. Dan,

    As usual, an interesting and informative post.

    As originally conceived eons ago, hedge funds were just what the term implies — a means of hedging one’s long investments by offsetting short sales of, theoretically, inferior companies and their stocks — particularly when markets “appeared” to be overheated..

    The last ten years and certainly for a good deal of time before the last decade found the so-called (I consider them generally misnamed) hedge funds up to their eyeballs in every conceivable speculative (and highly leveraged) investment that the creative mind of man could conceive. Is it any wonder, with the rampant speculation and gambling that occurred that the returns would be so meager? Perhaps investors supplying the bankroll might have done better if the funds had been invested at a poker table in Vegas?

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