Hedge fund / active manager haterade?
Curious if any of you guys at HF’s or other type of active management frequently get shade from finance folks who don’t work in the same space. Could just be a bad run lately but there’s been a good handful of folks passive aggressively coming at me. It’s always some variant of “just FYI brah it’s not actually possible to beat the market, even when you think you did it actually was luck”. Takes different forms but that’s basically the vibe, and it comes out of nowhere sometimes.
Only been really at it for about a year so just curious if this will be routine.
Yeah it happens but to be fair, they're probably right most of the time... if we simplify the world to only vanilla long-only equity funds, then by definition less than 50% outperform over X timeframe... even then, there are probably those who outperform by luck so maybe it's 30-40% who are "legit." Obviously this is a very simple view of the world and there are layers that haven't been explored...
I think we all have a view, at some level, that we aren't within that 60-70% for one reason or another but 99% of people in the industry think the same thing so who the fuck knows
I guess it’s the blind application of odds that surprises me. Like the odds of getting a record contract are really small. But if you met someone who says they’re a singer and you haven’t heard them sing, it would seem odd to just say “well you’re not going to make it because so few do.”. It would seem the only person who would react that way would be a failed singer who wants to believe nobody else can make it.
I feel like most don't understand what I do. Therefore, they don't have any hate. The only time I've seen hate is when a trader made more than the CEO. The CEO wasn't happy.
Where do yo work? What is your HF strategy? Where can a trader make more than the CEO?
Let me clarify because my initial comment was missing information. The CEO situation was for a company that has an internal hedge fund separate from its core business, that takes internal and external capital. I'm not going to state where I work or what your strategies are. Internal compliance wouldn't be happy.
I believe hedge funds broadly get hate because of high fees, large egos, and over-promising. I hate a person like that too.
Bp and Citigroup have definitely done that.
Name checks out
Happens all the time and from all sources. Unfortunately, the people in our industry and their character in general, as well as how flashy so many of them can be, does not help in endearing them to the population. So no one should be surprised when it comes to this kind of stuff.
In many ways the criticism is true. Most active managers in the LO and HF space don't beat the S&P (whether or not that's a far benchmark is another topic - I know where I stand). Most don't beat their benchmark either. Not for the long term. This is because performing gets tougher as one gets bigger and essentially is limited in the number of investment/trading possibilities that will have a meaningful impact on the portfolio. The other issue is that most managers are incentivized to grow assets. One either does that via connections/some angle with investors, or (more often) with previous good performance, which brings in some fish, which brings some size, which brings in big fish, which brings in everyone.
As AUM increases, so do expenses, but not by the same magnitude. After all, a $5bn investment manager punting various products may not employ 2x more people or have 2x office space or back office or whatever costs if he gets to $10bn. He will however, probably have his fee income doubled. By this point, the big cheese (or cheeses) that run said organization are incentivized to keep that capital at bay.
Institutions are generally not prone to moving fast and so will often use any excuse not to pull out (they don't want to tell their bosses that they made a mistake in giving the manager money). And their bosses don't want to go to their bosses (boards composed of people who have zero investment experience and don't follow markets) and so often only leave after performance is bad and for a while (note I have not mentioned under-performance compared to any index here).
This incentive to grow and keep assets is present both in the long only and HF world. Of course HFs will be more aggressive as investors/traders given that there is the 20% performance fee they want to make but the risk tolerance to try to knock the lights out with really good investments will be severely diminished as failure could lead to a declining attractive annuity income stream for the man (or men) up top.
In short, in many ways it's a scam. And I say this as someone who has sat on many sides of the table in this game including managing a portfolio. Furthermore, for truly long term investors, active management doesn't work out, not only due to bad incentives (ie managers raking in fee income), but because life happens. Markets change. What worked yesterday may not today, and what works today may not work tomorrow.
Managers are human too (as we often seem to forget). This means, like us, that they take dumps, sleep, eat, want to be loved etc etc etc. At a point these guys lose interest and get bored of the grind. They want to sail or spend time with family or on the private jet. They expand into products they know nothing about, to try to build an empire (read more fee income). They outsource things, like investing and buy a professional sports team. They start doing things they know nothing about. All of this also usually leads to worse performance. Then they shut up shop and give back capital (by this point a number of institutions have already redeemed or have been complaining for years). And the institution is stuck trying to find another place to park the money.
If anyone got through that... Here's the kicker and the rebuttal I use in such conversations. And I have had countless numbers of them.
HFs and active management ARE NOT for regular people or individuals. Ever. Regular people should keep costs low and do 70/30 whatever in index funds. Now people's eyes light up. "What wait, you are in the biz and a professional and so you are advising what?"
This is when I tell them to think about pensions, endowments, etc. These folks have to pay out to fund retirements or school cafeterias/research etc no matter the market situation right? I usually get a nod. These investors need to pay out the same amount no matter what right? Another nod. Then I say, usually they need to pay out 4%-5% a year to cover those costs. No matter what. So what do they want? Do they want years up 30% and years down 20%, to get an average return of 15%? Or would they rather have good years up 10% and bad years flat or down 2-3% and generally average 8% or so?
Folks then are like, "well I want 15% I can stomach it" but the pension/endowment.. Oh I get it. And then I tell them, yeah, that 8% consistent product, yeah, investors will pay hand over fist for it.
And then some folks say "Yeah but it's still a scam"
And I just smile.
You can't win them all.
.
Maybe worse than brainwashed. How about biased. Who isn't going to allocate to a manager that is more likely to offer them a job down the road? How is an E&F employee supposed to be aligned with the foundation's beneficiaries when the foundation is long-term minded and the employee is just there for a job?
My strategy for example, should be ideal for an institution. Highly concentrated, very choppy in short term, with very high long-term expected outperformance. Should be ideal for them. But if the allocating employee isn't going to be around in 5-10 years to enjoy the spoils of that outperformance (and does it hit their bonus anyway?) then why the hell should they take a risk on my near-term performance, which matters to them but not the foundation.
Most E&F staff don't end up joining funds and if they do, it's at a very senior or IR level. These guys don't work hard, make decent coin, work 40 hours a week in general, fly business class etc. It is the highest sharpe ratio job in the industry, especially at a sizeable one and why they are so hard to get because no one wants to leave (unless to go to another one). Then they just invest alongside Yale or whoever.
With all due respect "very choppy in short term with very high term expected out-performance" is the exact opposite of what these places want. @PteroGonzalez" you are in theory correct. That is what permanent pools of capital SHOULD target. But you forget that E&Fs need to make at least 5% a year because they have to pay out that amount. Without new subscriptions (read: donations) they are in trouble. So the key is to try and find 8%-9% lower vol across market cycles. The decent years should help build enough of a cushion for the not so great ones.
The strategy you are talking about is GREAT for aggressive and nimble family offices and individuals. Sadly, not institutions. Not in decent size anyways. Especially post GFC. Hedge funds used to essentially be levered beta and promise better than market returns. We all saw what happened in 08/09.
You talk about E&F staff leaving within 5-10 years. The same issue is prevalent for active managers. Some dude sitting at an E&F backs a fund, goes through committee and all of these hoops, get approved and invests. 2-5 years down the line the manager or stars leave for a better deal or retire, lose money and shut up shop or markets change or whatever. Of course the manager has made plenty of personal money and is off. Now what's the E&F guy supposed to do?
Oh yeah, he's avoiding trying to get fired for making said selection (and he hasn't made that much coin in the meantime)... Frankly, he probably blames Yale or the market or whatever and stays (which is what everyone in the industry seems to do).
It is why there are so many crowded trades and why some funds are so popular. If Yale of CPPIB or whoever is in, others can pile in because they know/think these guys did decent DD and if it fails, well, the best of the best failed, right? There is some plausible deniability there.
I think Jamoldo brings up a lot of good points.
Not the original topic but as it shifted to allocations - it makes sense why many large allocators don't contribute to traditional value style hedge funds / have small allocations / only back larger funds. I think the the argument that allocators dont know what they are doing shows a lack of fundamental understanding of what they do and what they manage.
I think a way to think about allocators would be similar to a conservative high yield manager - mostly invest in BB (traditional fixed income / equities), some B (real estate / PE) and a sprinkle of CCC - hedge funds. Going back to all that efficient frontier stuff - the hf goal is to merely optimize the portfolio as a whole.
The other big thing is scale. Large allocators need to cut huge checks. You're not going to invest into small HFs because the numbers don't pencil out. Its either gonna be a small check, which people dont want, because its a waste of resources for diligence to deploy a small chunk of capital, its not really going to move the needle even if they did and the fund crushes it because the allocation is small, and they dont want to be large percents of funds. Therefore they are going to stick with the bigger HFs. I believe it was calipers that said they were exiting HF investments in part because they had too much to deploy and couldn't hit the scale they needed.
In regards to beating the market, as other have stated, for a small strategy its certainly possible. Though its really in part to taken on way more risk than being better per se. Not that there is anything wrong with doing so. But with scale its just way harder to consistently have large amounts of capital deployed and out performing.
I also don't blame people for harping on the 2/20 fee structure - this would go for PE too. Dont get me wrong, I'm a beneficiary, but its a really weird system. If an engineer determines a new way to spec something that saves 100mm a year, they dont get paid more than their normal salary yet on the buyside there is a massive uptick in comp. I think capital is really what makes money and being a steward of it isn't as hard as people make it out to be - at least at the high ends of the comp range. At a minimum, HFs should have the PE style 8% hurdles. Kinda funny you can make 3% on year as still take 20% of that.
This is a great post and a must read. Thanks for the contribution. SB
You're on the money. Alternative investment strats, having a gigantic AUM makes you vulnerable to poor returns given a need to deploy capital but hey, it isn't easy finding a balance between deploying equity and finding large scaled return opps.
Given recent market conditions, I have one thing to say to those whote hate on low-net hedged portfolios:
"How d'you like' dem apples?"
In all honesty, tough first quarter for everyone. To all those in whichever investment strategy, hope all is well during this time of volatility.
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