Given that hedge fund assets are 8-10% as large as mutual fund assets, is the asset class too big to outperform?
Soros's argument is that given the prevalence and power of hedge funds as an asset class, they cannot outperform. It is almost a tautology that not everyone outperform the market, but has this alternative asset class reached such a stage?
The hedge fund tendency to lag equity markets are a recent phenomenon and to be fair, is a not exactly a fair comparison. After all, if alternative investments are meant to be less correlated with the market, doesn't that by definition include the possibility of under-performance?
Nonetheless, there is no shortage of studies showing how smaller managers outperform larger ones. Moreover, asset growth often goes to the larger, established ones and ones with the most best marketing/sales force. Perhaps the best example is this article about changes in the industry, quote below:
[Hedge Funds] need to excel in three areas which include: having a high quality
product offering, a marketing message that clearly and concisely
articulates their differential advantage across all the evaluation
factors investors use to select hedge funds, and finally, a
best-in-breed sales strategy. This sales strategy can be achieved by
either building out an internal sales team, leveraging a leading third
party marketing firm, or a combination of both. Firms that do not excel
in each of these three areas will have a difficult time raising assets.
Compare this quote with this article from nymag from a few years ago:
It doesn’t take much. To run money, which is how managers refer to what
they do, requires little more than a few computers. Zach’s boss likes
to say, “I could run $100 million by myself.” The theory is that they’ve
got an almost athletic gift for investing. They’re the type who can, as
one manager did, call the direction of the market correctly 22 days in a
row. They don’t want (or need) the kind of marketing, sales, and
investor-relations apparatus that comes with, say, a mutual fund.
Now, the latter is of course hyperbole, but to me the intent is clear. The core of managing money to outperform is to focus on investing/trading, not top-notch third party providers, sales/marketing etc.
In short, the alternatives industry is not so alternative anymore, and in my opinion the institutionalization of the industry is exactly how most (and in aggregate) won't outperform.
*Funny doc I came across while researching marketing docs: this looks like a well-put together marketing presentation, and they have pwc as auditor + citco as fund admin, both large, well-known providers. Unfortunately, they had a sad ending.
(icon source: https://newspaper.li/hedge-funds/)
They're too big to outperform as long as the people running them are unwilling to stop accepting new investment. We have a hard stop on our AUM in terms of new money right now and I don't think every HF manager in the world would have the discipline to do that when they could be making 1-2% on some stupid 10-figure sum and then basically indexing the rest to pick up a few more percentage points. If you can't cap your capital then you're forced to keep putting it to work or risk diluting your returns, and at some point you hit a wall when you just can't put any more money into your good ideas. That's when Danoff-ing happens.
Some HF managers have been showing a lot of discipline. I know a guy who is really good friends with Klarman and Baupost still won't take a dime of his money. But yes, sometimes I see a $10Bn "opportunity fund" and scratch my head..it's tough to find 10bn worth of diamonds in the rough.
Right.
Totally fair. It's had me thinking, if these investments aren't so alternative anymore, what will be?
Not at all discounting the sentiment of this thread, but if I head one more (just ONE more!) "too big to Blank", I will seriously blow my brains out.
IT'S NOT CLEVER ANYMORE.
Study shows small HF Managers outperform large ones (Originally Posted: 02/18/2013)
According to this study http://allaboutalpha.com/blog/2013/02/18/smaller-hedge-fund-managers-ou…, small HF Managers outperformed large (over 500 MM AUM) ones. Accordingly,
Virtually all of the outperformance was due to alpha, not beta;
and
The dispersion of returns among smaller funds was greater than those of larger firms.
Makes sense. The return on my portfolio when I had 20K was much higher than now where I have to figure out a way to invest 100K or whatever.
Scale.
Good post, although not anything new.
And even the small ones can't outperform the market...
I did a quick calc on the total return of SPY over the past 10 years and got ~7%; the study shows small HF's got 7.6%. I'm not sure if that's net of fees or gross, but if it's net then the small HF's clearly beat the market (although at a much lower Sharpe ratio).
Overall, you're right, hedge funds on average don't really do better than the market. But at least you get to roll the dice, right?
At least you get to roll the dice?
Since the sharpe ratio is lower, I could just lever up and get greater returns for the chance to roll the dice.
I enjoy analyzing companies so I've always thought about working for a hedge fund, but I'm not sure how I could justify my profession. What do people within the industry think? Is it taboo to talk about it?
It's a lot easier to turn $1m into $5m than it is to turn $1b into $1.5b.
Plus when dealing with smaller money, you are able (and it makes sense for you) to invest in smaller companies whose prices may not reflect the semi-strong form efficiency.
There are numerous small funds that have extensive market beating track records.
If that is not value added enough, a fund, large or small, can execute particular strategies that you cannot capture via an index such as take privates, activism, pairs trades, and so on. I can think of at least a couple of really awesome small funds that have destroyed the market using one of those strategies, but the problem is they don't scale to large AUM $.
The really questionable funds are those large funds that try to raise $2B and do stupid things like invest in gold. Really? Charging 2/20 to invest in gold? Who are the stupid LPs that invest in that strategy... I have some magic beans to sell them.
Why would anyone intrinsically care about the strategies that a fund can perform? All that should matter are risk-adjusted returns.
Mortgage arbitrage would be based on information and data arbitrage. You have a pool of mortgages that are performing well, but since the market to a huge slap, they are trading at a discount to par and also to COLLATERAL value. Having proprietary data and being able to analyze the underlying mortgages better than the market gives you a competitive edge over the market, thus creating arbitrage opportunities.
Maybe this is an easy way to explain it. Let's say you have a pool of residential mortgages that's trading at 70 cents on the dollar which represents 100K per home.Your data and your analysis tell you that the homes are worth 150K each, so the MBS is trading at a deep discount which is creating the arbitrage opportunity. Of course, defaults, prepayments, recovery rates play a big role.
Because from an asset allocation perspective they may want to build a portfolio of "investments" (in different funds) that have different strategies, exposures and theoretical correlations. That's pretty standard investment theory and there's nothing particularly novel about that concept.
agreed re: name, need to find less cliched intros!
It's more about relative size to the opportunity set than it is absolute size. A lot of fund managers don't (or can't because they're area of expertise is more limited) scale back certain strategies to fit the current environment. You can be a huge fund and kill it when price inefficiencies are abundant, but you also have to know when to stop or scale back when they aren't (doesn't necessarily mean decreasing AUM either). In most areas this is cyclical. So no I don't think this is true, but right now there are too many buyers trying to force their money to work, which is never what you want to do. It's a discipline problem, not a size problem.
very strat dependent
This. Macro funds aren't running into many size issues.
As with a few of the top managers, they have all stated that size matters and indeed it does since there quantity limitations in all asset classes, a bias will disrupt supply demand balance.. It just happens so that the quantities tend to be larger in macro, but it does not necessarily mean theres no limit.
Just look at Bridgewater for example, it is large no doubt but do note they do not focus purely on investment returns. They often do more hedging type or back to back services. Also larger macro funds have had many issues in 2012 with performance and many of them arent small in size so I wouldnt agree with the statement that macro funds arent running into size issues. Think the only guy who did exceptionally well for end 2012 to ytd 2013 is Soros ..with the JPY trade.
Vel sunt eum quia minima sed ratione. Quia amet eaque libero dolorem reprehenderit unde nesciunt facere. Assumenda tempore accusantium perspiciatis voluptates sed maiores. Commodi atque soluta eos numquam quidem dolorum ducimus doloremque. Et ullam itaque voluptatum voluptatum dolorem harum. Qui voluptatem tempore quaerat.
Sed sint nulla provident alias expedita dolorem quod. Vel ratione molestiae quos aliquam reiciendis sunt corporis. Odio voluptas sed dolorum dolorem.
Et qui nihil odit in asperiores et repellendus. Ut est qui nisi et quod. In tempore doloremque culpa dolor.
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...
Fugit harum quo provident rem necessitatibus necessitatibus. Ea ducimus qui voluptas neque repellat nesciunt hic. Quia est rem et sed provident qui tempore. Saepe rerum consectetur vero dicta qui et ratione. Praesentium aliquam ipsa id error deleniti cupiditate. Et eligendi est minus excepturi. Nam ullam sint nesciunt sit officiis.
Est facilis ipsam ab sed in consequatur. Optio error cum inventore tempora minima non fugiat. Qui voluptatem sit quam voluptas hic quos in voluptatem.
Quasi minus ipsam qui quidem hic. Non occaecati dignissimos omnis. Qui non voluptas ut error deleniti omnis totam ut. Voluptatem ex amet nihil rem quas. Repudiandae ut rerum in dolorem.