Every year there is this hedge fund conference called Delivering Alpha. I really don’t get it. Hedge funds often charge a standard 2/20 for the privilege of allowing you to give them your money. 2/20 means that that every year you pay them a 2% management fee of your total assets of yours that they are managing. The 20 is 20% of the profits that your money that they manage; yes, they also take 20% of the profits. It doesn’t matter if they beat the market or not; they take the 20% even if they don’t beat the market. For example, if you give them $1M to invest then they take a $20,000 annual management fee. On top of that they take 20% of the new gains so if after 1 year the portfolio is worth $1.2M (a 20% gain) then they take a 20% cut of the gains. In this example, the gains are $200K ($180K after deducting the 2% management fee); so they grab another $36K (20% of $180K) for total fees of $56K. This means that you’ve made a net $144K or 14.4% even though the investments in the portfolio increased by 20%. A smart person who can do basic math would expect their hedge fund manager to outperform then market by a lot; otherwise, it’s better to just invest in the S&P 500.
How are the hedge funds doing in 2018? Well, through the first half of 2018, the combined returns of the hedge funds is a gain of 0.08% (that’s not 8% but less than 1/10th of a percent). Meanwhile, the S&P500’s performance through 6/30/2018 was 1.95%. This means that the hedge funds are underperforming the market by 1.85% and those who gave them their money just paid 1% to them in management fees for the first half of 2018; so their investors are down about 0.9% which is a an underperformance of 2.85%.
I don’t understand why investors give them money to manage or why people listen to their opinions so much. I suppose that the lack of financial education by hardworking people has a lot to do with this. When someone doesn’t know something then they tend to look to an authority. The problem is that these hedge fund “authorities” are raping their investors. What a racket!
Apologies for this being a bit off-topic, other than being an example of why investing for yourself can be such a better option than paying fees.
A related thought, think of the “conventional wisdom” of the 4% safe withdrawal rate. That 2% management fee is essentially half of that. That 2/20% fee structure is a complete racket. Even thinking of a “low cost” mutual fund that is “only” charging 1% is taking essentially 1/4 of the “safe withdrawal rate”.
I have a little money in a mutual fund (Nationwide Growth Fund) that my grandpa bought/started for me back in the mid-1990’s or thereabouts that I’ve been planning to move over to my self-managed side. I looked through the holdings a few days ago, and recognizing a solid 85-ish% of the companies in it and thinking they’re all pretty solid companies, I thought that I might just let that money stay in the funds. Seeing this post, however, reminds me of the dastardly cost exhibited by fees, so I may dig deeper into that fund before making a final decision. For full context, not that anyone asked, the mutual fund amount is in the neighborhood of 8% the size of the value of my self-managed portfolio.
I second that about not giving your money hedge funds. But in fairness it should be pointed out that “hedging” does not work well during a vigorous bull market when almost everything is going up. It works better in sideways or down markets. Me I don’t do it, I just sell down in declining markets. While investing a hedge fund may not be such a good idea ,it is a great idea for managers of these funds, heads they win, tails you lose.
It also doesn’t make sense to say investing in hedge funds is a terrible idea because on average they do poorly. As an individual investor you would presumably be vetting the fund managers and investing with ones that you think will do well. It’s like saying investing in stocks is a bad idea because the total market is lagging behind the S&P or whatever other benchmark you want to use.
If Saul said he was going to start a fund (hedging or not) and charge those fees, he would get plenty of investors based on his performance. He could point to 30 years of 30% compounded growth. A novice investor would happily give him money when he could say taking 2/20 from his portfolio would have still resulted in a 20% compounded growth even factoring in the lumpiness of the market. Plus, having the capital opens to them investing options that simply are not available to individual investors, which is another thing they can sell investors on.
it is a great idea for managers of these funds, heads they win, tails you lose.
It’s more like heads they win (but you probably win more), tails you lose (but they still win a bit). And for many investors, if they don’t participate in the coin flip they’ll lose as well (investing poorly on their own).
Where do I sign up? I would happily pay someone else even 2% to maintain the 37-40% annualized IRR I’ve had since mid-2014 (in part, certainly thanks to Saul)… but which takes a SIGNIFICANT amount of my time each week to maintain. I can get more money, but sadly I can’t get any more time.
Almost no hedge funds charge 2/20. Yes, the fees are ‘high.’
Hedge funds actually hedge long positions with short positions, their goal is not to match the S+P which is 100% long large-cap stacks.
Most hedge funds are not pure equity - there are bond, convertible, distressed, currency and commodity, on top of the international and EMG funds. Again, not apples to apples for ‘the market.’
I don’t understand why investors give them money to manage
I don’t understand why investors give them money to manage or why people listen to their opinions so much.
Here is an example:
You are an athlete who just got a $10M signing bonus…and you didn’t do well in math class (or maybe didn’t attend)
Or you have any other high paying job where it is a better/more fun use of your time to work than to spend time investing – such as a top tier actor, etc.
This is why so many got fooled by Bernie Madoff. His funds were good enough for various famous rich people…must be good for me.
When it comes to rich people they do not trust you if you make too great of a return, it scares them. They think you are being too risky.
If you are a corporation or a pension fund or the like, you need a guaranteed minimum return. You do not want any less than this, and you are not rewarded for anything more, so the hedge fund creates financial strategies to insure your needed rate of return. It is often looking for risk free returns through arbitrage across the world that have micro-second differences in prices, to stock option strategies, too who knows what else. That is why I do not run a hedge fund, I keep it simple.
But those are two legitimate reasons why so much money goes into hedge funds.
I do not believe that Bernie Madoff was a hedge fund. Madoff was a money manager for rich people who thought they found a wizard when really all they needed to do was find David or Saul, but you know, we folk on the Fool are too pedestrian for this sort of ilk who invested with Madoff.
I know an attorney in town who comes from a rich family. His family and inheritance was taken by Madoff. I think they ended up getting some back. But you can certainly tell by body language what class one is born into. I have a similar arrogance I guess but with a bit more punk and chip on my shoulder vs. born better than everyone else. Despite this, we are all born where we at are born, a lot of great people born with that privilege as there are born where I was born. I can careless. Just an observation I have made over the years.
But anyways, Madoff not a hedge fund, hedge funds serve specific purposes I am sure beyond just what I wrote above, but I believe that is the gist. Pension fund has x liability and needs minimum y return without losing money to meet x liability. Hedge Fund “guarantees” through their financial acumen they will get it for them.
Btw when I say this, I mean they guarantee this return no matter what the market at large does, up or down. So they are not looking to asset allocate but use sophisticated mathematical financial strategies to make it so.
But mostly off topic and you got me talking about it. I shall depart the thread.
I don’t understand why investors give them money to manage or why people listen to their opinions so much. I suppose that the lack of financial education by hardworking people has a lot to do with this.
Outside of endowment, trust monies, there are many successful individuals give money to these guys. While one can argue about the performance hedge funds, don’t insult the intelligence of the successful individuals… Recently I had an opportunity to talk to an NBA player, not really successful, I am pretty impressed, behind the tattoo’s, rough exterior and some profanity laden speech, a very sharp mind, amazingly kind, and pretty intelligent… The best part is we hardly talked about basketball, and he is able to talk about his book in real detail…
I must say I am humbled, and learned success is not just extreme talent in an area… but requires lot more…