My dad is consistently trying to show me articles how hedgefunds are BS and how they "can't even beat the market". Then proceeds to show countless articles comparing hedge fund performance in the last 8 years compared to the s&p and index funds. I don't know enough about the subject to even respond to him. I know many people say it's bc we're in one of the longest bull markets we've ever seen. Can anyone elaborate further? Completely ignorant on the subject.
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I presume this discussion with your dad stems from your desire to work at a hedge fund rather than an evaluation of whether hedge funds are a good place to invest money. The reason why the industry has stuck around despite the lackluster returns these articles point to is that hedge funds make money off management fees that are independent of performance. For large funds, this 2% or whatever it may be amounts to a lot. Moreover, even if on average HFs lose to the S&P there are still some guys like Dalio and Singer who consistently outperform. As an investment vehicle, HFs benefit from flexibility (they can adopt aggressive strategies like short selling and do not have to be fully invested at a given time). Thus, for the time being, they're here to stay.
The reason why the industry has stuck around despite the lackluster returns these articles point to is that hedge funds make money off management fees that are independent of performance.
This makes no sense.
All of this "beating the market" stuff is literally just completely meaningless. Most equity hedge funds are ... wait for it... HEDGED. They shouldn't beat fast rising markets - they should slightly under perform rising ones and (hopefully significantly) outperform imploding ones. The focus is on RISK ADJUSTED returns.
Many hedge funds also invest in other markets (credit, macro, etc), so the performance of the "market" (S&P500) is just a completely meaningless metric by which to judge. If you want to outperform the S&P lever yourself up moderately in an ETF and hope we don't experience a massive bear.
Actually the focus for hedge funds is absolute return and not risk adjusted return. Conceptually, HFs should make money when markets are good and when they're bad. They're supposed to successfully time markets, which they almost never do. The argument that HFs are a low beta asset class, comparable to gold but with a 20/2 fee structure us laughable. You hear this shit all the time when things go south.
After reading some of your other comments, I'm going to throw it back at you and be blunt: everything in this response is just plain stupid and illustrates that you don't understand the hedge fund world.
"Conceptually, HFs should make money when markets are good and when they're bad. They're supposed to successfully time markets, which they almost never do. " - Who told you this? Only a small minority of the HF world would claim to gain edge from 'successfully timing markets'. There's a way you can make money in various market environments: BE DIVERSIFIED AND HEDGED. This means that you will almost certainly under perform when markets move up aggressively.
Several of the biggest hedge funds in the world (see: Millennium Management) are basically incapable of putting up a 20% year. How have they gathered so much assets? Because on a risk adjusted basis their performance is excellent - they have never had a losing year and rarely have multiple down months.
You also didn't address the rather big point: WHAT MARKET? If you want to beat equity indices then there is no real point in investing in credit, macro, etc. Yeah there are credit indices to comp to as well, but there is no 'index' for macro performance.
"The argument that HFs are a low beta asset class, comparable to gold but with a 20/2 fee structure us laughable." - Is this a joke? Gold is an insanely volatile asset that is sometimes (but not always) inversely correlated to equity markets. I don't know any hedge fund that would aim to have performance 'comparable to gold'
The bottom line is that most of the capital in hedge funds in in funds that are selling hedging, not out-performance of the market.
Yes, indeed, my point was a very simple one, but you appear to have missed it...
More generally, it's likely that even the simple mean-variance framework that you appear to be so fond of isn't sufficient to explain the performance of a particular class of investment/strategy. Higher moments matter and sometimes they matter a lot. It's entirely possible that at least some of the broad class of strategies offered by HFs offer some particularly valuable characteristics. Alas, with your penchant for over-generalisation, you're probably not interested.
Yes, the modern hedge fund industry, as I've highlighted many years ago on this forum, is an entirely inefficient investment vehicle that persists primarily because of tradition and regulations associated with the SEC act (regulation D and what not).
In the past, hedge fund managers were more successful because public markets where less liquid, efficient and diversified. As global markets continue to evolve (more and more markets opening for previously illiquid assets, greater efficiency with HFT, introduction of various hedging securities, etc.) the ability to generate persistent alpha diminishes, if not vanishes altogether.
Hedge funds under preform on an absolute and on a risk-adjusted basis. Their portfolio's consist of investments in international markets with high country risk premiums, in small caps and in illiquid assets. This alone should generate higher absolute returns (though not risk-adjusted returns) but doesn't. HFs themselves are an illiquid investment that carries a required premium. Your money is tied up for a certain period of time which introduces another dimension of risk. The poor performance, in every dimension, and the insane fee structure simply won't persist. This is why we're seeing and will continue to see a secular decline in the industry.
This is not to say that all hedge funds will go away. There will always be the "smartest guy in the room" but the pretenders won't be able to make as much money as they have (if any at all). This is part of a broader trend in finance towards greater market efficiency that will impact not only HFs but also IB, S&T (already has), PE, VCs, etc. It isn't surprising to anyone that understands financial theory conceptually. It's only really a surprise to those who have completely rejected theoretical finance altogether.
The HF industry is literally based on the denial of science. So yeah, it won't last and at this point, that's blatantly obvious.
You're sounding a little shrill here. Agreed that the ubiquity of most popular algorithmic strategies and the relative ease with which one can acquire the minimum necessary infrastructure to start up a hedge fund are factors which will contribute to the continuing shake out of smaller players from the industry in coming years (along with other factors you mention, like the introduction of new derivatives and diversification).
But to suggest that HFs are going the way of the dodo? Dream on, man. In many ways the fall of HF's from grace is the result of them being a victim of their own success. It's hard to capture market inefficiencies when you and your cohort have already so effectively exploited and undone these same inefficiencies.
Your argument misses the point that HFs fulfill a unique role within the financial ecosystem - namely, their purpose is to seek out and capitalize on inefficiency in the public markets. Without them, there is no other profitable, institutionally accepted, ubiquitous means for tasking capital with ferreting out market inefficiency.
You're right that the dissemination of information - both in the form of info that supplies model inputs as well as the academic papers containing the models themselves - will limit the ability of novice players to stake out a space for themselves in the industry. But for those survivors who can afford to invest in proprietary data and infrastructure, there will always be a place, because there's no other commonly accepted vehicle for deploying "skeptical" capital into public markets.
Too many posts to read through the thread, but I've addressed this issue on a different thread before. Hedge funds are NOT designed to beat the market, but rather to hedge, hence the term "hedge fund", their portfolios are designed such that their funds produce a return in both upward trajectory and downward trajectory markets. They do still have a place in the investing landscape, but only for quite specific circumstances, such as those who make enough money to stuff their 401ks and ROTHS (if they don't make too much) very year and still have more than enough for a taxable investing accounts.
Not all hedge funds are designed to act alike and not all have the same egregiously high fee structure of 2 and 20 (2% of AUM and 20% of profits annually). My former FA gig had a massive number of investments, mostly their proprietary portfolios based on a specific strategy (conservative, moderately conservative.... aggressive, etc.), but they also had a long/short fund that acted much more like an ETF than a hedge fund and the fees were much more palatable than the 2 and 20.
Personally, I've been in the markets for decades, I have enough to be "qualified" for a position in a hedge fund, but as the saying goes: A fool and his money are soon parted.
Point is, if I can't net at least the same returns over a 3, 5 or 10-year period as a HF, once fees are included, then what the hell did I spend all that time learning the inner workings of the FA profession. Not always, but I consider professional wealth management to be a rather shady profession. Not to say there are not good, legitimate FAs, but the industry is cutthroat, I've heard numerous stories of "low-fee" wirehouses who just stick their clients in A-share MF's that are mediocre at best.
I mean, I guess I can see putting some people in a MF over an ETF, but A-shares over I-shares, Z-shares or others that would alleviate that big front-end load the client has to pay when buying A-shares? To me, that borders on unethical, but it happens every day.
Won't say the name of the firm, but one of the most commoditized FA firms on the street are notorious for doing precisely what I just mentioned previously. They love to push their American Fund A-shares, which just soaks their clients, and the products are, well, IMHO inferior to a number of other fund families.
Got waaaaaaaaaaaay off on a tangent. Sorry to anyone who is still reading.