Why do allocators give $ to HFs?
It doesn’t make any sense. SMs have not beaten the market and MMs have a real alternative with corporate bonds at 8-10% returns.
don’t give me crap about UnCoRrLaTeD and RiSk AdJusted returns… PE has way better returns (15-20% IRR) and no volatility. There are stocks up or down 50% on earnings, how can a fund manager be comfortable with that vs a PE portico is way more stable valuation wise and can sell to continuation vehicles that help prevent drawdowns
so LPs have option of index (awesome returns and less vol), PE (awesome returns and superior structure preventing vol/drawdown), bonds (non equity 8-10% returns). WTF is a HF adding value here? QQQ was up 50% and no one was close
Here we go again ...
(Btw PE doesn't have no vol. Rather, it's vol-washing)
Public stocks are up/down 30% on earnings. You’re telling me a PE company is that volatile? Not true. Plus they can sell to themselves/continuation funds to cap downside
Bro is neck deep in the kool aid. If that’s how you think about vol you will never work in high finance. Vol is an intrinsic property of an asset not something determined by a mark.
Did you understand what I said? Vol-washing means that private markets mask their true vol because these assets aren't marked to market. I don't understand why there are finance professionals out there who actually think PE have less Vol - i thought only retail investors would be fooled by vol-washing
(Furthermore, selling to self or secondaries/ continuation doesn't exactly cap downside because it's just playing musical chairs. That's no diff from thinking you can cap downside in publics via the greater fool theory)
IRR is not a good measurement of returns as it can heavily be manipulated by choosing holding periods etc. Also, PE funds normally do not mark to market and thus as mentioned above smooth the volatility of their underlying returns by doing so. There is a lot of research done by AQR and others that you can gain a similar return profile like PE by levering a small cap ETF.
As far as why would it make sense to invest in HFs from an allocator point of view? It is much easier to meet return and vola targets using HF vehicles compared to going long delta one the stock market. Most allocators have an investment mandate which specifies specific constraints (e.g. max drawdown, max illiquidity exposure, max duration, min diversification, max sector allocation etc) and are thus not focussing on total return. Therefore, just because an allocator underperforms the stock market with his/her allocation does not mean they missed or underperformed the targets of their mandate. HFs offer further diversification in addition to delta one stock and bond holdings in an allocator's portfolio as most HFs operate in a somewhat market neutral way, you therefore broaden your investment universe and lower your portfolio vola by investing in them. Given the strategies they implement, good HFs also achieve much higher Sharpe ratios than pure market ETFs could ever achieve (just look at the big MM HFs which average a Sharpe well above 1 with the market being closer to 0.6). As said before, most allocators are not given pure total return mandates which leads to them preferring investments with a higher Sharpe ratio. HFs also allow investors to harvest risk premia that can not be harvested by using long only products only which again further adds to diversification and risk adjusted returns.
So basically, HFs allow to broaden the investment universe allowing for better diversification, easier return targeting due to lower overall vola and higher portfolio Sharpe ratios. Of course many HF vehicles are not worth investing in and are heavily overpriced, but that is the general rational allocators follow when making their decision.
This is for sure a troll post
Who tf says awesome returns
Common, PE takes a lot of time to create returns, from that POV is not even comparable to HF
Pretty sure the OP is a troll. But he's not wrong that the *vast* majority of hedge funds that will actually accept your money (no fair counting the ones that are closed to new investors like RenTech) will 1) underperform index funds over the long run, 2) are NOT uncorrelated, NOT lower risk, and NOT more tax-efficient, and 3) have additional burdens like less transparency and gates preventing withdraw of your money when the funds underperforms.
I get voted down everytime I say that, so go ahead and vote me down again, or tell me again "But top funds like Citadel aren't like that (if you ignore 2008 when Citadel was exactly like that)". But it's true for 95% of funds.
I'll pick off one anecdote before a longer reply - but yea Citadel 2008 is quite different than Citadel today.
It is the same as it ever was, and everyone already answered it above: people have different volatility and duration targets, and using different HF vehicles as an addendum to your exposure elsewhere can be beneficial for the endowment or pension fund managing tens of billions with money they need to be able to spend in +20 years. Your mandate as an allocator is not necessarily to beat the market every year, but rather will I be able to have $xyz in 5, 10, 15, 20 years from now, regardless if there is a massive recession the year or two before xyz year in the future. This is clearly not the only way funds get money today though (more about that later).
But yes, you are right, many funds don't live up to the hopes and promises they dish out. This underperformance pressure has been present forever, and will continue to shape the future of the industry.
Additionally there are still a decent amount of "legacy" funds from different time periods that were more absolute returns / rockstar like returns focused, which continue to operate today, with legacy investors who nicely outperformed their benchmark on a since inception basis (but maybe less so on a 5-10 year basis anymore...). People chase returns, and the incentives here are fighting with the changing landscape, which is why many of yesterday's rockstars are below their peak AUM, and some are not. Their value prop has shifted over the years, and I am sure it will be harder and harder to justify their existence in some ways.
Lastly, the allocator is just like today's stock picker, and as such, there are a ton of different views. Some of them are pursuing a mathematically and semi-efficient market hypothesis framework and reducing vol and managing exposures and risk units, etc. Some of them are more simply pursuing someone to make them strong absolute returns for the next 5 years... sometimes with a GP stake. So sure, your average stock may not outperform the benchmark, but the idea is to find a stock that will put up attractive returns. We can debate active vs. passive to death here, but there are still a lot of talented managers who have been able to generate attractive returns with a bit less risk and capture the best of the bull markets (and potentially deliver true alpha!). It is getting harder and harder to do that, and that is why we have seen MMHFs take share more recently, as their value prop is a bit clearer. Allocators aren't searching for average outcomes though, just like a stock picker isn't searching for average outcomes.
This industry is built on incentives, the results of which aren't always optimal, and on average, an investor (either allocator or stock picker) may not get the best deal or invest in the most optimal fashion with hindsight. But in the search for fat tails and/or reducing risk, HFs will continue to have a place.
1. PE has no volatility on a mark to market basis, but it has plenty of volatility on a final return basis.
2. When people say any type of fund (SMs in your case) doesn't beat the market, they're just talking about the average across that class of funds. Not much reason to expect that an individual SM of your choosing will underperform the market.
3. I agree with you that uncorrelated returns and risk-adjusted returns are largely bullshit excuses for underperformance because the S&P generally isn't risky enough to justify lower returns from any individual manager. But when S&P has shown itself capable of 30% drawdowns in the past, and today's conditions are arguably conducive to a deeper drawdown (more monetary/Fed questions these days, very heavy S&P concentration in tech & M7) I can see how an LP gets convinced that a particular fund has less drawdown risk or less correlation to today's big sources of risk.
By definition, 50% of funds have to be below average, even before fees. So then add on a 2-and-20 fee plus the short-term cap gains tax that you'd avoid with an index fund, and yes, there is reason to expect any individual SM of your choosing will underperform the market.
We are all aware of how averages and fees work. That's not a good reason for an allocator (someone who has dedicated his career to selecting outperformers) to think that a fund he's diligenced and chosen will underperform.
There are several reasons why allocators, such as pension funds, endowments, and other institutional investors, give money to hedge funds (HFs):
Potential for alpha: Hedge funds, with their flexible investment strategies and ability to take on both long and short positions, can potentially generate alpha, which is returns that exceed the market average. This return enhancement is why investors turn to HFs even if their fees are higher than traditional investments.
Portfolio diversification: Hedge funds can offer diversification benefits due to their unique strategies and asset classes they invest in. This can help to reduce overall portfolio risk and volatility, especially during periods of market downturns.
Access to specialized expertise: Hedge funds often employ highly skilled and experienced investment professionals with expertise in specific sectors or strategies. This expertise can be difficult for allocators to replicate internally, making HFs an attractive option for accessing specialized investment knowledge.
Alternative investment exposure: Traditional asset classes like stocks and bonds may not always meet the desired risk-return profile of investors. Hedge funds provide access to alternative investments, such as private equity, distressed debt, and real estate, which can offer different return streams and potentially help to achieve specific investment goals.
Performance fees: While hedge funds typically charge higher management fees than traditional investments, they also often structure fees based on performance. This means that investors only pay additional fees if the hedge fund generates positive returns, aligning their interests with those of the fund manager.
Liquidity options: Some hedge funds offer investors different liquidity options, allowing them to withdraw their capital within certain timeframes. This flexibility can be important for some investors who may need to access their capital on short notice.
There are several reasons why allocators, such as pension funds, endowments, and other institutional investors, give money to hedge funds (HFs):
Potential for alpha: Hedge funds, with their flexible investment strategies and ability to take on both long and short positions, can potentially generate alpha, which is returns that exceed the market average. This return enhancement is why investors turn to HFs even if their fees are higher than traditional investments.
Portfolio diversification: Hedge funds can offer diversification benefits due to their unique strategies and asset classes they invest in. This can help to reduce overall portfolio risk and volatility, especially during periods of market downturns.
Access to specialized expertise: Hedge funds often employ highly skilled and experienced investment professionals with expertise in specific sectors or strategies. This expertise can be difficult for allocators to replicate internally, making HFs an attractive option for accessing specialized investment knowledge.
Alternative investment exposure: Traditional asset classes like stocks and bonds may not always meet the desired risk-return profile of investors. Hedge funds provide access to alternative investments, such as private equity, distressed debt, and real estate, which can offer different return streams and potentially help to achieve specific investment goals.
Performance fees: While hedge funds typically charge higher management fees than traditional investments, they also often structure fees based on performance. This means that investors only pay additional fees if the hedge fund generates positive returns, aligning their interests with those of the fund manager.
Liquidity options: Some hedge funds offer investors different liquidity options, allowing them to withdraw their capital within certain timeframes. This flexibility can be important for some investors who may need to access their capital on short notice.
Thank you ChatGPT
Stonks only go up bruv
Exactly.
Former pm and current allocator here. Troll or not some of the main points made by the opp are more than reasonable. Ignoring PE, the HF world is saturated with funds that bring no one any value. And that’s allocators fault for not correcting mistakes that have been made…
Libero maiores id molestiae qui quo. Beatae fuga rerum tempore enim. Voluptates qui consequuntur voluptate dolorem et. Non laborum voluptatem asperiores adipisci officiis alias id. Ducimus labore ad et aut voluptate. Consectetur dolore reprehenderit ut soluta. Qui sit consequatur asperiores velit.
Cumque dolores ut delectus inventore tempora sapiente rerum. Sed aspernatur neque neque corporis perferendis dolores vero. Ex ipsa eum et molestias iure. Quis et aut quibusdam amet molestiae. Magnam minima cumque distinctio repellat autem.
Pariatur ut eos et. Tempore itaque inventore sed provident voluptas dolorum recusandae. Nihil tenetur et voluptas repudiandae quaerat vel nulla omnis. Quia esse omnis soluta excepturi sit esse praesentium hic.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...