Why does everyone hate hedge funds?

I just don't get the hate towards hedge funds and successful investors in general. I get that some people (i.e. Rajartnam) cheat the system and should be prosecuted but lots of it seems overblown. For example, people compare Stevie Cohen to Madoff yet Cohen's been watched like a hawk by the feds for 10 years and nothing has come of it. However, Madoff was basically given free reign to ruin thousands of peoples lives while he ran his ponzi scheme.

Also, considering how much time and money the SEC and the feds seem to spend on insider trading am I crazy to think that their are a few Enron's out there that they've missed? Also, interest rates are near 0 so a company like Enron could go on for a while with borrowed cash. Also, based on the recent PwC Herbalife news it doesn't seem like the SEC is getting any tougher on the auditors: I can't post links but there is a forbes article on it.

 
  1. People like to generalize. They see the mistakes of a few and blanket the whole industry with the same perception.

  2. It's a zero-sum game. The money that people lost didn't vanish. Some hedgies made a killing. The general public feels cheated.

  3. It's a lot easier to hate something you don't understand.

  4. The media likes to sensationalize everything. People care more about entertainment than they do about real news.

 
Best Response

People don't know what hedge funds are or what they do. In fact, the vast majority know next-to-nothing about finance in general. They think it's one giant casino where rich people gamble the life-savings of 'hard-working Americans.' In fact, most people in finance can't even intellectually defend their field. They're incapable of explaining, for example, the value they create by adjusting market prices in accordance with fundamentals which in turn facilitates the flow of capital towards warranted economic activities, therefore promoting general efficiency.

All of the CEO's that the average people idolize, like Jobs and Gates, would be nothing if it weren't for finance. Their ideas would be just that--mere ideas. Also, I do agree that all of the focus on IBS and HFS may very well be directing attention away from firms that are truly engaging in criminal activity.

“Elections are a futures market for stolen property”
 
Esuric:
They're incapable of explaining, for example, the value they create by adjusting market prices in accordance with fundamentals which in turn facilitates the flow of capital towards warranted economic activities, therefore promoting general efficiency.>

Ever tried to convince someone who has had no economics training how important efficiency is and the importance of rational capital markets?

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
Oreos:
Esuric:

They're incapable of explaining, for example, the value they create by adjusting market prices in accordance with fundamentals which in turn facilitates the flow of capital towards warranted economic activities, therefore promoting general efficiency.>

Ever tried to convince someone who has had no economics training how important efficiency is and the importance of rational capital markets?

This argument is so overplayed...

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Esuric:

People don't know what hedge funds are or what they do. In fact, the vast majority know next-to-nothing about finance in general. They think it's one giant casino

I would love to hear a cogent argument on how a hedge fund's operations are significantly different than playing poker at a casino. I'll give you a hint...it's not. It's a game in which imperfect information and odds are used to make bets that are influenced by future events that you cannot foresee or control.
 

Poker is a good analogy, but it doesn't really provide any support to a position that a hedge fund's operations are 'one giant casino'. I'm going to go ahead and presume that the view most people have is of someone spinning the roulette wheel and a bunch of fundies betting on different numbers (in fact I'm not presuming, I know people who think this). The general public don't understand that for a few skilled players, poker is a game that can be consistently 'beaten' over a long time period, just like the market.

The difference is, whereas in poker the expected value the pros place on the pot often can't be seen by the general public, in the market the value the pros place on securities is what dictates the price of the securities--creating a more efficient market.

 
Going Concern:

I would love to hear a cogent argument on how a hedge fund's operations are significantly different than playing poker at a casino.

I'll give you a hint...it's not.

It's a game in which imperfect information and odds are used to make bets that are influenced by future events that you cannot foresee or control.

So because there is incomplete knowledge and because we employ various types of probability when we gamble and when we invest you therefore conclude that there isn't a fundamental difference between the two?? So, according to you logic, there's no fundamental difference between entrepreneurship and gambling, since the entrepreneur, like the gambler, faces 'imperfect information' and uses 'odds to make bets that are influenced by future events that cannot be foreseen or controlled.'

The gambler is primarily concerned with class/frequency probability (based on an infinite, indiscriminate series of events) while the entrepreneur/investor is primarily concerned with case/Bayesian probability (varrying circumstances which may be known before the fact that impact the outcome). Hedge funds don't make investment decisions by coin-flipping (or by pulling stocks out of a hat, or by throwing darts at a newspapers financial pages); they make decisions based on macroeconomic and microeconomic factors, they look at upstream and downstream industries, foreign markets, demographic trends, managerial structures, the actual products that the firms produce, etc.

The fact that some hedge funds do indeed gamble, or that individuals have earned a higher ROR by coin-flipping (or some form of it) is entirely irrelevant. What's important, and I mentioned it in my original response, are the effects of the investment decisions and the losses/gains made by the funds (the dispersal of information to the market and the subsequent effect on prices).

Finally, poker is unlike most forms of gambling because it does, occasionally, involve the use of case probability (i.e., picking up a tell and using that as an advantage), but in the vast majority of the cases it primarily involves class probability (the use of pot odds, calculating the odds of making your flush, straight, figuring out your outs, etc).

“Elections are a futures market for stolen property”
 
meekrab:

Well they take 2 and 20 and as a group don't beat index funds, that's a pretty good reason to hate them?

maybe a good reason not to invest in them, but not hate them.

Because when you're in a room full of smart people, smart suddenly doesn't matter—interesting is what matters.
 
meekrab:

Well they take 2 and 20 and as a group don't beat index funds, that's a pretty good reason to hate them?

Please explain.

First, many HFs aren't benchmarked against the S&P using a basic return format. HFs care about risk-adjusted returns.

Secondly, wouldn't underperformance of a basic investment index make the general person, who is unable to invest in HFs, feel indifferent? Why would they be pissed if their returns are outpacing returns of the HF group?

 

1) Steve Cohen is not running a ponzi scheme, I get so many people even people with accounting degrees and finance degrees saying oh Steve Cohen is stealing clients money and that how he had such high returns blah blah blah..... IF he did do anything it MAY be insider trading, and that is not bad. sure its cheating, but if i where invested with Cohen i would be so happy, i would try and give him all my money, as long as I he never says yes to it, Im happy with the 30% yoy returns. 2) Herbalife is not a ponzi scheme.... sure it is sucking the consumer of it's product dry of cash, for a crap product that doesn't work, but at the end of the day it's numbers are there and not forged. the only thing herbalife is doing wrong is screwing over the people who use its product, besides that its fine.

 

The average individual associates hedge funds with "arrogant and wealthy individuals running risky trades." That general opinion is primarily driven by a lack of understanding as well as the media's sour portrayal of the hedge fund industry. For example, when LTCM was bailed out in the late 90s as a result of their over-leveraging, people began subsequently linking HFs with risk. During the great recession, as unemployment skyrocketed, some hedge funds were making millions. The fact of the matter is, LTCM and the profitable HFs during the great recession represent only a few funds in an industry of over 6000, but their demeanor represents a consenting opinion amongst the public.

What the public doesn't understand is that a hedge fund's quintessential purpose is to hedge risk by generating uncorrelated returns, hypothetically creating a safer investment. This also makes the returns of hedge funds arbitrary with any index.

As far as the SEC goes, remember they are a government agency. If criminals can get IDs under an alias at the DMV, corporations can get away with dirt. That's a huge problem with government agencies. There are only a limited amount of SEC agents for many, many complaints that they receive.

Portfolio manager of a boutique value-oriented long/short and event-driven hedge fund Disciple of Graham since the age of 12 Started an investment fiirm and two funds at a young age, all you young-lings interested in hedge funds, pm me.
 
MLCM:

What the public doesn't understand is that a hedge fund's quintessential purpose is to hedge risk by generating uncorrelated returns, hypothetically creating a safer investment.

That's not true, hedge funds aren't safer investments. Especially when you throw in leverage, derivatives, short positions, high concentrations or high turnover, illiquid investments, etc. Hedge funds have high return requirements (even if they aren't explicit), and there's no such thing as a free lunch.

 
Going Concern:
MLCM:

What the public doesn't understand is that a hedge fund's quintessential purpose is to hedge risk by generating uncorrelated returns, hypothetically creating a safer investment.

That's not true, hedge funds aren't safer investments. Especially when you throw in leverage, derivatives, short positions, high concentrations or high turnover, illiquid investments, etc. Hedge funds have high return requirements (even if they aren't explicit), and there's no such thing as a free lunch.

They are not safer per se, they help to create safer investments (hence why they are called hedge funds).

You only invest in a hedge fund if you are wealthy otherwise (e.g. own millions to billions in relatively non-diversified wealth) and want to hedge that wealth.

If you want to "simply" invest (and not hedge your wealth) it's obviously better to invest in ETFs or traditional mutual funds.

 

The most life-altering document you'll ever read for those of you that think hedge funds actually contribute to society. GMO White Paper, November 2011. Pretty solid evidence that hedge funds pre-fee performance can be easily replicated with a simple rolling put selling strategy.

http://spectruminvestors.files.wordpress.com/2011/11/rethinkingrisk_bet…

So basically; hedge fund managers are making billions and adding no real value to society. You could pay an asset manager less than 100 basis points to run such a strategy and make much more money than if you paid a hedge fund to do it. Why people pay hedgies 150+ basis points plus 20% carry is beyond me. Maybe it's because institutional investors are retarded and/or have a vested interested in keeping the insanity going? This is theft through ignorance/stupidity. No more worthwhile a career than a used car salesman who sells cars worth $10K for $20K.

Any of you monkeys want to start a hedge fund and become a hecto-millionaire? Just do this exact strategy described in the white paper but charge 1 plus 10 instead of 1.5/2 plus 20. Your performance post-fees should be significantly better than the average hedge fund (not crazy amazing, but you'll look solid). Grow subscriptions using your track record, make more money. Never tell anyone too much about what your strategy actually is. Make some bullshit up and put that in your prospectus (but be sure to say you can deviate from the strategy whenever you see fit). Get various custodial accounts and hide the fact that all you're doing is selling puts on the index (do puts on the co's that make up the index, do some covered calls, etc.).

I had a hedge fund. I was stupid and didn't do this (I didn't want to essentially scam people - instead my strategy actually had zero correlation with the market and HFRI). In retrospect, if I had done this, I'd probably be up to at least $50M AUM by now and sitting pretty. Oh well, still happy with how things turned out regardless hahaha :D

PS - Link to the academic study mentioned in the footnote in the GMO white paper: http://www.hbs.edu/faculty/Publication%20Files/12-013.pdf

 
alexpasch:

The most life-altering document you'll ever read for those of you that think hedge funds actually contribute to society. GMO White Paper, November 2011. Pretty solid evidence that hedge funds pre-fee performance can be easily replicated with a simple rolling put selling strategy.

Ask anybody trading during the 1980's how well naked shorting puts worked out. During bull markets it's always popular but one massive downward move can not only wipe out your account but leave you owing your broker huge sums of money.
 

People hate hedge funds because it doesn't make sense to them that people that do nothing but move capital around can become so wealthy. They don't see them as creating real value in the way Jobs, Gates, and other famous wealthy people did/do. Sadly, research shows that the general public's intuition may not be ill-founded at all. It's a classic fooled-by-randomness type of problem, mixed with some general institutional investor misunderstanding about how to measure risk.

 

I can rationalize why people hate them: They are typically individuals who are paid massive amounts of money by rich people, to make the rich people richer.

The whole arena in which hedge funds operate in are very far removed from average society and are very elitist so it is easy to portray them as such.

"History doesn't repeat itself, but it does rhyme."
 
  1. Much easier to blame the successful for your failures than take ownership of your own life
  2. Anything successful money wise will garner a lot of hate, Lebron James, the jersey shore, the kardashians, Ceo's etc.
  3. Don't understand the space
  4. Media nonsense saying "all" Wall Street people steal for a living and then pointing to the cases where people are actually stealing. Trying to put the failures of a few choice men on an entire industry
  5. Not publicly disclosed, so just like people being skeptical of a public company that is not transparent, people generally hate on things they don't "know" for sure. Kind of like that jackass who always tells you to show him a "PHD study" to prove something or else he won't believe it.
 

I understand the role that hedge funds play in making capital markets efficient, but I do not understand why anyone would invest in one. Study after study has shown that hedge funds consistently under-perform the market, even on a risk-adjusted basis.

"My dear, descended from the apes! Let us hope it is not true, but if it is, let us pray that it will not become generally known."
 

if you think uncertainty in poker is primarily concerned with calculating pot odds and straight draw outs you should just stop talking about it to avoid embarrassing yourself further. going concern has some excellent points, poker and investing are fundamentally quite similar, although the structures of the games and nature of uncertainty is quite different of course.

 
leveredarb:

if you think uncertainty in poker is primarily concerned with calculating pot odds and straight draw outs you should just stop talking about it to avoid embarrassing yourself further.

Uncertainty has nothing to do with calculating pot odds, you moron. Why don't you understand what we're discussing (hint: uncertainty is not the same as risk) before you make ridiculous comments and accuse people of 'embarrassing themselves.'

leveredarb:

going concern has some excellent points, poker and investing are fundamentally quite similar, although the structures of the games and nature of uncertainty is quite different of course.

You're just regurgitating the argument that I addressed in my previous response without actually responding to any of the points I made. I introduced a distinction between various types of probability, one that defines gambling and another that is key in investment/entrepreneurial decision making. I concluded by stating that both forms are present when it comes to poker, but that one is far more prevalent (namely frequency probability).

Anyone that doubts this simply doesn't understand poker. The type of person who memorizes all of the WSOP champions, read Doyle Brunson's book multiple times, but spends most of his time talking about bad beats while throwing away his bi-weekly check at his local 1-2 no limit game.

“Elections are a futures market for stolen property”
 
Esuric:
leveredarb:

if you think uncertainty in poker is primarily concerned with calculating pot odds and straight draw outs you should just stop talking about it to avoid embarrassing yourself further.

Uncertainty has nothing to do with calculating pot odds, you moron. Why don't you understand what we're discussing (hint: uncertainty is not the same as risk) before you make ridiculous comments and accuse people of 'embarrassing themselves.'

leveredarb:

going concern has some excellent points, poker and investing are fundamentally quite similar, although the structures of the games and nature of uncertainty is quite different of course.

You're just regurgitating the argument that I addressed in my previous response without actually responding to any of the points I made. I introduced a distinction between various types of probability, one that defines gambling and another that is key in investment/entrepreneurial decision making. I concluded by stating that both forms are present when it comes to poker, but that one is far more prevalent (namely frequency probability).

Anyone that doubts this simply doesn't understand poker. The type of person who memorizes all of the WSOP champions, read Doyle Brunson's book multiple times, but spends most of his time talking about bad beats while throwing away his bi-weekly check at his local 1-2 no limit game.

Esuric:

Finally, poker is unlike most forms of gambling because it does, occasionally, involve the use of case probability (i.e., picking up a tell and using that as an advantage), but in the vast majority of the cases it primarily involves class probability (the use of pot odds, calculating the odds of making your flush, straight, figuring out your outs, etc).

I was referring to this statement above, this is completely incorrect. At any okish level of play (lets define as MSNL online on US sites and above so 2/4, 4/6+ online), you are primarily concerned with playing against your opponents range in any given spot(I.e. case prob.), calculating pot odds or odds of making your flush is a base for that but in the larger picture of things its not that important.

I dont know what this WSOP champion bs is about lol, what stakes and how many hands have you played the game for (300 live hands at 5/10 lol?)

Referring to some of the other posts, Whilst the distinction of poker = zero sum, investing = not zero sum is correct, relative performance compared to an index is zero sum and relative performance is what people are concerned with at the end of the day in active fund mgmt, otherwise you can just buy the index.

 

Leaving aside all the talk do HFs have any worth (in general, the answer to that type of question is really deceptively simple -- if they didn't, people wouldn't pay them. Restaurants exist to give people a place to go eat for fun), clothing stores exist to give people cool stuff to wear, hedge funds exist to invest capital via alternative strategies)...

This whole 'the HFRI index has returned blah blah blah' is total BS that has been perpetuated by dumb academics and a couple wily HFs (Bridgewater in particular uses its armies of fresh college 'investment associates' to create marketing research saying how much better they are than the competition and they provide alpha while everybody else replicates beta, which for the most part, is horsecrap).

Nobody invests in the HFRI -- nobody can invest in it, and nobody wants to. Hedge funds are not an asset class. People invest in HFs to get idiosyncratic exposure to manager talent. Good hedge fund managers with long track records have outperformed over long stretches (there are many of these)...this is why (smart) people keep giving them money to invest.

Also, I'm guessing if hedge funds are really hedged, you would expect the entire universe of funds as a whole to generally underperform their indexes assuming an upwards drift in the market (assuming that HFs are now a sizeable enough chunk of invested capital that as a whole the universe has to broadly be exposed to its underlying asset constituents) -- and I would think this is why HF indexes tend to replicate beta when taken in the aggregate

 

The difference between gambling and investing, and what separates "good" hedge funds from the kind that generate negative headlines, is all about downside risk. Whether ex ante rational/NPV-positive on a probability-weighted basis or not, any bet in poker or any other form of gambling has 100% downside risk on the basis of a binary event.

While it's entirely possible to run a hedge fund that way and many people have, it's not really what the vehicle was first created to accomplish. Sure, any stock could go to zero in theory, and you can customize virtually any risk-reward tradeoff using derivatives, but the original purpose of the industry was to provide a less volatile ("hedged") means of investing, less subject to the whims of the market. Done properly, that means less downside in bad times, not more upside in good times!

Secondarily, many hedge funds exist to offer exposure to particular asset classes or investing styles, and the problems come largely from the inherent risks of some of those approaches. Want a hedge fund that puts everything on red? Sells naked puts all day long? Levers up 5x? 10x? Bets everything on a couple ideas? The barriers to entry are low and as long as people keep funding moon shots, there's a product for every buyer. But properly managed "hedge funds" in the original sense of the word don't blow up.

A classic long/short fund making prudent, diversified investments without too much leverage is just as safe as any mutual fund. Arguably, the ability to sell short and not have to remain fully invested during a market collapse makes it safer.

 
tempaccount:

The difference between gambling and investing, and what separates "good" hedge funds from the kind that generate negative headlines, is all about downside risk. Whether ex ante rational/NPV-positive on a probability-weighted basis or not, any bet in poker or any other form of gambling has 100% downside risk on the basis of a binary event.

While it's entirely possible to run a hedge fund that way and many people have, it's not really what the vehicle was first created to accomplish. Sure, any stock could go to zero in theory, and you can customize virtually any risk-reward tradeoff using derivatives, but the original purpose of the industry was to provide a less volatile ("hedged") means of investing, less subject to the whims of the market. Done properly, that means less downside in bad times, not more upside in good times!

Secondarily, many hedge funds exist to offer exposure to particular asset classes or investing styles, and the problems come largely from the inherent risks of some of those approaches. Want a hedge fund that puts everything on red? Sells naked puts all day long? Levers up 5x? 10x? Bets everything on a couple ideas? The barriers to entry are low and as long as people keep funding moon shots, there's a product for every buyer. But properly managed "hedge funds" in the original sense of the word don't blow up.

A classic long/short fund making prudent, diversified investments without too much leverage is just as safe as any mutual fund. Arguably, the ability to sell short and not have to remain fully invested during a market collapse makes it safer.

I disagree. Druckenmiller, Soros, PTJ,... in the early days took MUCH more risks than the average HF do today. This "hedge " thing is mostly a marketing thing to describe new funds that took on new bets that were forbiden to other type of funds. (shorting stock, leveraging,...). More money than god is a very good book that explain this in details and much better than I do.

 

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