How Do Hedge Fund "Geniuses" Einhorn and Ackman Still Have Any AUM?

So hedge fund "genius" David Einhorn is down 18 percent this year, even though the S&P is up 5 percent.

Last year, his fund gained 2 percent while the S&P gained 22 percent. He slightly underperformed the market in 2016, while getting crushed in 2015 when he LOST 20 percent while the S&P gained 1 percent.

Same thing with Ackman. Through June 5, his Pershing Square hedge fund had returned 7.5 percent for 2018, handily beating the S&P 500's 3 percent gain. But this is the same guy who:
o Lost 20.5% in 2015 when the S&P gained 1 percent.
o Lost 13.5% in 2016 when the S&P gained 12 percent
o Lost 4% in 2017 when the S&P gained 22 percent.

So over the last 3 years, while the S&P was up more than 34%, Ackman lost his investors 38 percent... and he's still got 8 billion under management!

Why are these guys still considered the "smart money?" And if you had millions to invest, why the hell wouldn't you just put it in a Vanguard Index fund instead of with them?

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Comments (124)

Aug 1, 2018

I too have wondered this for quite some time.. TBH maybe it is because I do not know better, but I just can't seem to understand why millionaires would put money into a hedgefund at this point in time. It has been proven time and time again that long-term they do not beat the market. 2% in last years market? That should be illegal.

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Aug 16, 2018

Millionaires who made their money in something simple like, say, a catering business, are dazzled by MIT engineers and Harvard MBAs using terms like "sharpe ratio" and "stochastic."

Finance just isn't that complicated...

Aug 1, 2018

From what I've read, Ackman's fund is suffering huge outflows at the moment because of his failed crusade against Herbalife. It all catches up to you eventually.

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Aug 1, 2018
Armadapk:

From what I've read, Ackman's fund is suffering huge outflows at the moment because of his failed crusade against Herbalife. It all catches up to you eventually.

Herbalife
Target
JCPenney
Plus others that are not in the headlines

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Aug 16, 2018

Don't forget Valeant (loss $4bn)

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Aug 16, 2018

Chipotle

Aug 24, 2018

Hey he won on Nike 50-70 in like two months a solid scalp.

Array
Aug 1, 2018

These funds have clauses that limit the rate at which you can redeem (10% per quarter, as an arbitrary example), and as Armada pointed out above me I'm sure they're hemorrhaging capital. It's only a matter of time before their short term track record is going to make it impossible to attract new money and net flows will bleed them dry. You can only say "Yeah but look at our record from '04 to '09" for so long before people tell you to kick rocks.

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Aug 1, 2018

They will wind down the fund and raise capital for a new one. Rinse and repeat. People have very short term memory.

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Aug 1, 2018

Do you really think a cap raise on a scale that they saw on fund inception is going to be possible after their last few years coupled with an outlook toward negatively shifting flows moving forward? Not disagreeing with your prediction, more curious on how you see their potential success taking on new money.

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Aug 1, 2018

I think rich people view it as a status symbol: "Look at me, I am with Ackman and Einhorn." They think it makes them look like smart investors, but in reality, at least lately, it's made them look pretty foolish.

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Most Helpful
Aug 1, 2018

So uhh not that I have any specific opinion about Ackman or Einhorn but hedge funds are not really supposed to be benchmarked to the SP500... Hedge Funds are intended to be an alternative source of return that is uncorrelated to the overall market. Comparing the returns of hedge fund managers and the overall market during individual years makes very little sense.

The reason that people don't put all their money in a vanguard index fund is that is risky in itself! Being overexposed to the stock market is not considered a good thing by any serious investor. Nobody is putting their entire fortune or their entire pension fund into a hedge fund.

People mostly allocate portions of their portfolio to hedge funds, believe it or not, as protection against big market downturns. On an annualized return basis, both Einhorn and Ackman have done quite well. Looking at the returns of hedge funds vs the overall market for a few recent cherry picked years is not how anyone who knows what they are doing selects managers.

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Funniest
Aug 1, 2018

While this is true, no one is investing their money in HFs to underperform the S&P.

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Aug 1, 2018

Yes! This is what I am talking about. To consistently underperform the market average -- and by large amounts -- simply wouldn't be acceptable to me as an investor... especially if I'm paying the 2 or 3 percent in annual fees vs. 1/10 of a percent in an index fund.

Aug 1, 2018
MichaelScarn:

Yes! This is what I am talking about. To consistently underperform the market average -- and by large amounts -- simply wouldn't be acceptable to me as an investor... especially if I'm paying the 2 or 3 percent in annual fees vs. 1/10 of a percent in an index fund.

Remember. HFs usually lose money on their shorts. The reason hedge funds short is not to make money! It's to reduce beta exposure! Obviously in many cases, hedge funds believe they can make money from their shorts but the reason funds short is NOT, I repeat NOT, to actually increase return. It's to hedge against the market! Hence, HEDGE fund. You guys are reading too many New York Times articles or something about how hedge funds underperform the "market".

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Aug 6, 2018

This isn't true in all cases. A lot of funds these days only hedge interest rates and currency risk and take single name short positions intended to be alpha generating.

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Aug 7, 2018
Personofwalmart:

This isn't true in all cases. A lot of funds these days only hedge interest rates and currency risk and take single name short positions intended to be alpha generating.

In terms of systematic investing, negative return on your short positions doesn't mean it isn't alpha generating. If the stock you shorted underperforms the index, which it belongs to that is generating alpha. If index returns 10% and the stock returns 5% in some given timeframe and you short it, that is, from a systematic point of view, generating alpha. Of course shorting the stock, you'll still lose 5% return approximately. Nonetheless, that's considered alpha generating as the stock underperformed.

But you are probably right that in some cases, investors truly believe specific single name shorts will generate positive return. I would assume all the Tesla shorts believe this. I would assume that few, if any, hedge funds that have existed for more than a single market cycle have overall made positive return on their shorts.

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Aug 16, 2018
DeepLearning:

The reason hedge funds short is not to make money! It's to reduce beta exposure!

Losses are the new black!

You drank too much of the Kool aid my friend.

Aug 17, 2018
CuriousCharacter:
DeepLearning:

The reason hedge funds short is not to make money! It's to reduce beta exposure!

Losses are the new black!

You drank too much of the Kool aid my friend.

The purpose of shorting for the majority of hedge funds is for their longs to outperform their shorts consistently. It is OK if the short positions have negative return so long as the overall portfolio return is positive. That's how you define alpha for hedge funds... if the longs outperform the shorts...

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Aug 1, 2018
MMBanker14:

While this is true, no one is investing their money in HFs to underperform the S&P.

This is just not true. At all. Have you ever worked with anyone from a FoF? Everyone knows hedge funds underperform the S&P on a return basis. Hedge Funds have higher sharpe ratios than the S&P. That's why people invest in them.

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Aug 2, 2018

I can see that, but has there ever been a HF that has significantly underperformed for 5+ years and is out there raising a ton of $ successfully? I don't know the HF world well, but I can't eat sharpe ratios.

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Aug 2, 2018

I mean sure, funds who have underperformed recently will struggle to raise capital or will undergo significant redemptions. The point is that several years of underperformance is neither uncommon nor unexpected for hedge funds. This is particularly true for guys like Ackman and Einhorn who take much more concentrated positions. If their hit ratio is 60%, and they only make a few concentrated bets, it is no surprise that sometimes they miss several times in a row. As I mentioned in another comment, if they continue to do this poorly there will come a point of no return. That could very well happen. If it did, overall Ackman and Einhorn's funds have made their investors a ton of money and it would in no way invalidate their success as hedge fund managers.

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Aug 2, 2018

deleted

Aug 16, 2018

Well no, at some point, poor performance does invalidate their success.

Anyone can get lucky in the market. So, if you see someone with one huge winning year and a decade of sub-performance, it is reasonable and prudent to ask whether that person is lucky or smart.

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Aug 16, 2018

Yep. I just find it amazing that -- after these managers do have a good run, whether it's 1 year of 5 -- they can still reap literally billions because they've accumulated so much money based on their past successes. But I guess it's like the baseball player who has 3 great years, signs a $100 million contract, and then sucks after that. The only difference is, the team can't get out of the contract (MLB contracts are guaranteed), but investors (perhaps after a waiting period) CAN pull their money out of these former stars' funds... but many elect not to to do so. It's weird.

Aug 2, 2018

Hedge funds are, by nature, not designed to outperform the market using the market as its benchmark. They are meant to "hedge" out market risk to isolate some factor and therefore have very low correlations to traditional markets and provide an absolute return (say, LIBOR + 4% annually) every year rather than outperform some index. It's better to look at Sharpe/Sortino ratios (historical risk/return) than performance relative to something like the S&P500 (equity) or Barclays Aggregate (FI)

Aug 9, 2018

Luddite. You should do some reading on separating beta and alpha and the importance of diversification. Here's a good start: https://www.bridgewater.com/resources/engineering-...

Aug 9, 2018

This isn't true at all especially in a bull market. They are fine underperforming as long as their beta is lower or ideally 0 beta.

That being said these funds are not 0 beta. And furthermore they are doing very stupid trades.

Herbalife was a stupid trade....brontecapital did real time analysis that destroyed his thesis. I made money trading against him. Icahn made money against him. He had negative edge on the trade.

Einhorn been an idiot shorting fang. I mean I have no problem shorting Tesla as they have real issues. But shorting fb amazon google is only shorting companies on valuation (and their valuation isn't ridiculous).

A truly market neutral fund doesn't need to beat the snp to be a useful investment. Bonds don't beat the snp and people own them.

Array
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Nov 15, 2018

"Einhorn been an idiot shorting fang. I mean I have no problem shorting Tesla as they have real issues."

Yea, Einhorn is an idiot shorting fang, and you are brilliant shorting Tesla. Good luck, man!

Nov 15, 2018

You do see dates on those trades right?

Einhorn was short amazon below $900.

I mentioned short Tesla above this price and then it traded $250.

Way to pick a random comment from a long time ago and calling me an idiot because it's wrong over the last month.

Array
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Aug 16, 2018

No, it's actually not even true. If you mean hedge fund in a literal sense as an investment fund which attempts to take a net market neutral position, then yes @DeepLearning is correct.

However, if you're invested in a hedge fund that for example has a tech focus and is net long tech stocks. You get killed along with the rest of the market if it goes south...

Hedge funds these days take all sorts of positions at any given time. Net long, net short, neutral. In fact, if the fund is positioned the wrong way, you could be losing MORE than the S&P in a downturn.

Furthermore, if the fund in question is not following some sort of market neutral strategy, it is more than fair to compare their returns to things like the S&P.

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Aug 16, 2018
NoEquityResearch:

However, if you're invested in a hedge fund that for example has a tech focus and is net long tech stocks. You get killed along with the rest of the market if it goes south...

That's fine. Hedge Funds are not always beta neutral. That doesn't mean index funds are the right benchmark.

NoEquityResearch:

Hedge funds these days take all sorts of positions at any given time. Net long, net short, neutral. In fact, if the fund is positioned the wrong way, you could be losing MORE than the S&P in a downturn.

This is exactly the point. The purpose of a hedge fund is to attain a positive return regardless of the market condition. If the SP500 loses 20% and a hedge fund loses 15% in a given year. That's a very bad year for that hedge fund! For a long-only manager, that's a great year. 5% alpha! None of what you have said so far means index funds are a sensible benchmark for hedge funds. In practice, of course hedge funds have down years. But the max drawdown of hedge funds are generally much smaller than max drawdowns of any index fund, low vol or not. SP500 has had many 18% drawdowns. This is very unusual for a hedge fund. Less unusual for an Einhorn/Ackman strategy that is so concentrated though.

NoEquityResearch:

Furthermore, if the fund in question is not following some sort of market neutral strategy, it is more than fair to compare their returns to things like the S&P.

Dude, what are you saying? As you stated earlier, hedge funds take all kinds of different positions, not always maintaining market neutrality. That's completely fine. That does not mean that on an annualized basis, a long only index is a sensible benchmark. You need to go talk to anyone who invests in hedge funds. This is not at all how anyone benchmarks them.

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Aug 16, 2018

Also in this tech stock hedge fund example where the fund is net long, how net long is too net long? Do you need to have 10% long exposure? 40%? 90%? OK some hedge funds (or at least firms that market themselves as hedge funds) will be net long some of the time or all of the time. Does that mean an index fund is the correct benchmark suddenly? No, of course not. That would be asinine. If a hedge fund is consistently maintaining sizable beta exposure, consultants will look to see if that beta exposure generated alpha. Maybe the fund has some kind of macro view predicting a fall in interest rates and therefore a rise in equities. It's completely fine then for the fund to be net long. But again, that does not mean you benchmark to an index.

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Aug 16, 2018

Ok I got it....you track your performance against the indexes you choose. Well the market is picking up on this BS and dropping hedge funds left and right for index funds. So you can make up whatever kind of BS you want but money talks and it's flowing out of managed funds in a big way.

People are voting with their dollars and are saying that managed money is not delivering the performance that they want regardless of what relative index they are personally comparing it to.

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Aug 17, 2018
NoEquityResearch:

Ok I got it....you track your performance against the indexes you choose. Well the market is picking up on this BS and dropping hedge funds left and right for index funds. So you can make up whatever kind of BS you want but money talks and it's flowing out of managed funds in a big way.

People are voting with their dollars and are saying that managed money is not delivering the performance that they want regardless of what relative index they are personally comparing it to.

No, we do not track performance against the index we choose. The world of hedge funds is complicated and so are the benchmarks.

In no way saying that there aren't issues with hedge funds or active management. Most of the outflows are actually from long-only active strategies, not from hedged strategies. Hedged strategies are still bringing in big inflows. Two of the largest hedge fund launches of all time (D1 Capital and ExodusPoint) launched this year.

Long only managers who are benchmarked to SP500 and other major indexes are struggling because of the massive 9 year bull market. Most active managers have a value tilt and the bull run of the past 9 years, particularly in the last two years, has been driven by momentum/tech not value. So if you had a value tilt, you got destroyed. Active management is highly cyclical. The volatility spike in February has actually caused an increase in long-only inflows.

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Aug 17, 2018

Using your same logic, why should value managers be benchmarked to the S&P 500 either? Shouldn't they be benchmarked to some sort of other value index instead? Couldn't they also argue that their goal isn't necessarily to beat the market but to outperform value index XYZ or to execute some specific strategy?

See that's my problem with your arguments - it gives you a million ways to paint your performance however you choose. And that in of itself is BS.

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Aug 17, 2018
NoEquityResearch:

Using your same logic, why should value managers be benchmarked to the S&P 500 either? Shouldn't they be benchmarked to some sort of other value index instead? Couldn't they also argue that their goal isn't necessarily to beat the market but to outperform value index XYZ or to execute some specific strategy?

See that's my problem with your arguments - it gives you a million ways to paint your performance however you choose. And that in of itself is BS.

Long only managers are benchmarked against the index for the set of securities, which they have a mandate to invest in. If you have a US Large Cap fund, your benchmark is either SP500 or Russell 1000 because you are pulling from that set of securities. The point is that the majority of active management frameworks are around value investing. In the current market environment, prices are being driven by speculation that tech stocks are going to take over the world. Many fundamental value managers believe that trend will end and they don't want to be caught holding billions of dollars of tech stocks whenever that party is over. So, these managers are okay with underperforming during certain segments of the market cycle because they believe their investment thesis will end up being correct over the full market cycle. There aren't really any existing investment framework for the current market except "Amazon is going to take over everything so we should buy Amazon". Of course, nobody is going to pay for such a strategy because they can buy Amazon stock themselves. People don't benchmark against a "value" index because the investment thesis itself is that in the long run, value oriented strategies will outperform the benchmark, which they have (See Fama French).

Institutional investors are not dumb. Active managers can't just make up benchmarks that put poor performance in a positive light. What they do is communicate why the strategy hasn't worked so well in the current environment and why it will over the long run. When institutional investors are evaluating hedge funds, they know what they are doing. They know how to benchmark them and they understand what the role of hedge funds are in their overall portfolio. To think they don't is absurd.

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Aug 21, 2018

I admit freely to being a neophyte when it comes to the finance world, but my question in general is this.

"Genius" guys like Eichorn (to use the OP's term) are presumably out there raising a ton of money, or were out there raising a ton of money in recent memory, on the back of a couple very strong years, right? That is why they are "geniuses," they made a ton of money on individual bets and that made their rep.

I guess my overall question, leaving out the specifics of strategy aside, is why does anyone consider the net positive years to be more emblematic of a hedge fund's strategy and positions than the net negative years? That seems like a lot of confirmation bias to me. It's all well to say that hedge funds are deliberately not correlated to the "market" as a whole (whatever index or market that may be) and are thus trying to prevent negative returns as much as to generate positive ones, but it's undeniable that the pitch by HFs is that they've made XX% annualized return over (whatever random sample size they choose). Why do you consider the good years to be representative of investing acumen, and not the bad ones?

And moreover, I don't see why the S&P or any other individual market indicator isn't a good comparison over an extended period of time. On a year to year basis, sure, an index and a HF may not be expected to move in tandem, but over the course of 5 or 10 or 15 years or whatever, who cares? The whole question is how I make the most money, net. That the HF is going to preserve more capital in bad years means less over time if they miss on the good years, especially once you net out fees.

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Aug 21, 2018

Hedge Funds will report their annualized return over the entire history of the fund. It's generally the critics who will cherry pick the bad years.

Your comment about maximizing return over the long run indicates that you don't really understand portfolio construction or the principles that underlie it. And that's fine most people don't.

Let's assume a dollar neutral portfolio, meaning that 50% of assets are in long positions and 50% of assets are in short positions, Further, let's say there are roughly 25 stocks in the long portfolio and 25 stocks in the short portfolio. Holding periods of 3-6 months selected from the SP500. Given the bull market that has been going on since GFC, it's been basically impossible to identify shorts that actually produce positive returns. The objective of going short for hedge funds is to minimize volatility and market exposure. You can reduce the volatility of your portfolio from 18% annualized to 4% just by being dollar neutral. Of course, this will always sacrifice return. If the short portfolio underperforms the long portfolio overall then the hedge fund is delivering value. In a strong bull market like the one we have been in, that might be only a 2 or 3 percent gain net of fees and that would be completely acceptable, though not spectacular of course.

If investors sought out only the highest returning asset class, they would dump everything into a US small cap index fund. Small caps have significantly outperformed large caps in the US. Of course, that would be an utterly ridiculous decision to make.

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Aug 21, 2018
DeepLearning:

Your comment about maximizing return over the long run indicates that you don't really understand portfolio construction or the principles that underlie it. And that's fine most people don't.

This is very true, which is why I'm asking. I'm not in any kind of finance and don't pretend to have anything but a very high level knowledge.

That being said, if I am investing my own money, I ideally want the greatest possible net return on my dollars over a given period of time. I imagine that you can take an index and find a sample size which makes it look amazing, or you can find a HF that has a sample size in which it destroys index returns. But there has to be a period of time over which this normalizes. I understand that past performance isn't an indicator of future results and all that, but at some point claiming your protecting against volatility becomes meaningless, especially if you can't actually prove it out.

So if you're David Einhorn, and you pursue the traditional 70/30 model, but you don't actually capture 70% of the upside, why should an investor believe your capable of limiting your downside risk to 30%? In other words, there is clearly room for multiple executions of the same strategy, which means there is a real vulnerability to not executing. If you have a ton of HF that are pitching investors saying "sure, we're not competitive in the bull market, but wait until the bear market when you don't see your investment sink to nil," why should you believe them? They've already shown they can't pull through on taking 70% of the upside of the market, after all. To be clear, I am sure there is an explanation, I'm not proving a point, I'm genuinely curious. I understand the concept of hedging risk, but if your manager can't execute on one end, I'd lose all confidence he could on the back end, in which case, why not move into a more historically profitable (in the medium-to-long run) asset class?

Also, related question, if I am a long short HF manager, do I also take a carried interest in a bad year? In other words, is there a mechanism to equate the degree with which I've protected principle into how much money I've "made" my investors?

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Aug 21, 2018

Why would you ever hold a large amount of cash? They underperform bonds.

Why would you ever hold bonds? They underperform index funds.

Why would you ever buy an index fund? They have underperformed individual stocks (Amazon, Apple, etc.).

Why would you ever buy an individual stock? Crypto returned 5000 percent last year.

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Aug 21, 2018
DeepLearning:

Why would you ever hold a large amount of cash? They underperform bonds.

Why would you ever hold bonds? They underperform index funds.

Why would you ever buy an index fund? They have underperformed individual stocks (Amazon, Apple, etc.).

Why would you ever buy an individual stock? Crypto returned 5000 percent last year.

Um, I'm not paying 2/20 to do any of those things, obviously? C'mon, you're obviously a smart person, so work with me here. I can diversify myself in a number of ways without paying through the nose for the "privilege". HF managers make large claims for themselves and their strategies in order to justify their fees and their carried interest; it's only right that they provide evidence justifying those fees. What's the phrase? Extraordinary claims require extraordinary evidence? If I see someone claiming they can beat the market over the long term, when the vast vast majority of people can't, I am justified in asking for more than just a refutation through parallel reasoning, especially when I pay many multiples up front, and a significant piece of my back-end, to execute on one of those options.

From the comments I've been and the folks I know who have worked at newer hedge funds, it's pretty clear that most HFs can't justify their fees relative to returns, which is why you're seeing more and more funds charge less on fees or take a smaller piece of the carry.

Long story short, if you can't justify investing in a HF over any other self-managed investment, you shouldn't be advocating investing in a hedge fund.

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Aug 22, 2018
Ozymandia:
DeepLearning:

Why would you ever hold a large amount of cash? They underperform bonds.

Why would you ever hold bonds? They underperform index funds.

Why would you ever buy an index fund? They have underperformed individual stocks (Amazon, Apple, etc.).

Why would you ever buy an individual stock? Crypto returned 5000 percent last year.

Um, I'm not paying 2/20 to do any of those things, obviously? C'mon, you're obviously a smart person, so work with me here. I can diversify myself in a number of ways without paying through the nose for the "privilege". HF managers make large claims for themselves and their strategies in order to justify their fees and their carried interest; it's only right that they provide evidence justifying those fees. What's the phrase? Extraordinary claims require extraordinary evidence? If I see someone claiming they can beat the market over the long term, when the vast vast majority of people can't, I am justified in asking for more than just a refutation through parallel reasoning, especially when I pay many multiples up front, and a significant piece of my back-end, to execute on one of those options.

From the comments I've been and the folks I know who have worked at newer hedge funds, it's pretty clear that most HFs can't justify their fees relative to returns, which is why you're seeing more and more funds charge less on fees or take a smaller piece of the carry.

Long story short, if you can't justify investing in a HF over any other self-managed investment, you shouldn't be advocating investing in a hedge fund.

I think the bull market we have had due to multiple monetary authority's around the world pumping cash into the economies has distorted our views / expectations etc. Certainly in a bull market like was said above in terms of absolute return the best thing to do is to pick the winners, most people cant. Therefore buying an index / diversifying your stock base is the next best thing. The analogy a rising tide makes all boats float comes to mind in this current bull market. But if we go back 10 years how long did bull markets usually last without some form of a dip? In those market conditions where markets don't seem to go in just one direction having good money managers is clearly superior to just buying an index.

I think your point is accurate in regards to how can a money manager charge such fees in an environment like we have right now when low cost trackers / index's etc clearly outperform. But when markets return to a more 'normal' level of money supply that is when I believe we will see money managers earning their keep. I would rather get to annually compound x% rather than every n years have a crazy large draw down.

Aug 22, 2018
TradeGreek:

I think the bull market we have had due to multiple monetary authority's around the world pumping cash into the economies has distorted our views / expectations etc. Certainly in a bull market like was said above in terms of absolute return the best thing to do is to pick the winners, most people cant. Therefore buying an index / diversifying your stock base is the next best thing. The analogy a rising tide makes all boats float comes to mind in this current bull market. But if we go back 10 years how long did bull markets usually last without some form of a dip? In those market conditions where markets don't seem to go in just one direction having good money managers is clearly superior to just buying an index.

I think your point is accurate in regards to how can a money manager charge such fees in an environment like we have right now when low cost trackers / index's etc clearly outperform. But when markets return to a more 'normal' level of money supply that is when I believe we will see money managers earning their keep. I would rather get to annually compound x% rather than every n years have a crazy large draw down.

So this gets back to the initial point I was making. Obviously there are multiple executions on an individual strategy, since we have many HFs in the market (and did in the past, in a different monetary environment). Not all of them are succeeding equally, or even succeeding at all. If you have no guarantee that your being hedged properly, why bother? I'm in real estate development; I'm obviously subject to market forces, but at the end of the day my promote and my fee are because I am creating value in the investment. Ditto a private equity manager; whatever you think of it, their activism is generating the returns which they take a piece of. That doesn't seem to me to be the case for a HF. If they're sitting there promising you a limited downside of XX% and then trying to match the market in up years, that's one thing. But if you're taking the same crapshoot and hoping for lower volatility, all of a sudden that's a different story.

TL;DR - I get that HF managers aren't aiming to beat the market in bull years. But if they can't execute on the long strategy, why is there confidence they can do so on the short side? And if there isn't that confidence, what is the rationale for paying giant fees and carry for something any reasonably savvy investor can create a reasonable facsimile of for a fraction of the cost?

Aug 22, 2018

as long as the longs outperform the shorts, it's okay.

Aug 22, 2018

I think you are missing the point, look at the investment strategy see how they create value and then judge their returns for yourself. If you find a fund where the investment thesis makes sense and they historically never lose money I think thats a solid bet. If you want to compare 12% to 8% returns and will choose the 12% not taking into account risk then thats up to you. Good hedge funds reduce risk and the best will generate alpha on top of that reduced risk.

Aug 22, 2018
TradeGreek:

I think you are missing the point, look at the investment strategy see how they create value and then judge their returns for yourself. If you find a fund where the investment thesis makes sense and they historically never lose money I think thats a solid bet. If you want to compare 12% to 8% returns and will choose the 12% not taking into account risk then thats up to you. Good hedge funds reduce risk and the best will generate alpha on top of that reduced risk.

Yeah I'm not trying to argue hedge funds are a bad bet, I'm honestly trying to figure out where they're generating the value for which they charge. If it's purely that you give up some upside and protect downside, then obviously there is a class of investors who are going to love that. My point, to tie into the OP, is that many of these guys aren't generating value in the upside despite what their business strategy suggests, so why should I assume they'll be successful in protecting my downside? That's the explanation I'm looking for, as someone who genuinely knows very little about how HFs work (or little compared to folks on this site).

Again, if I am wrong about the way I'm thinking about the math, please smack me down hard, but this is how I view it. If I can make 10% a year over a 15 year period in an index (or some other market), and lose 50% of my value in YR 10, I end up with a 1.72x on my investment at the end of that hold. If my HF manager says they'll make 7% a year, but limit my downside in that bad year to losing 15% of my value, I end with a 1.81x or so. That doesn't seem worth it for the fees I pay and the back end I give up, and it especially doesn't if my manager is only managing to return 5% in the up years, or if they lose 25% of value, or whatever.

Is that absolutely not the right way to think about? I guess, as before, my question is why your average HF managers historic returns are any more trustworthy than the historic returns of the S&P 500?

Aug 23, 2018

you cant make such broad strokes though saying what if they make 15% instead of 20%. Also hedge fund is a pretty bad name as a lot of asset management funds like to call themselves hedge funds. There are hedge fund managers who produce positive returns every year regardless of what the market does maybe 2 - 3 % in bad years but still positive. There are also far too many hedge funds out there that are bad. At the end of the day you should look at a fund by itself. You want uncorrelated investments which hedge out specific risks you dont want or at least mitigate them that have good track records. Most importantly you need to believe in the PMs investment strategy.

In theory you should never hold all your money or even a majority of your money in any one investment. You want to diversify.

Aug 1, 2018

I fully understand you shouldn't benchmark hedge funds to the S&P. This said, in the '16-'18 market where you could literally throw a dart and pick a winner, how do you say to investors "look guys, I understand the market is up 20+% and we're down 5%, but you have to understand that we're a non-correlated asset class designed to cushion your overall portfolio on the downside." I'm not expecting outperformance during bull markets because I'm paying for that downside protection, but at what level of underperformance do you say enough is enough, literally holding cash is a better risk adjusted return than being in this fund. Hyperbole obviously but you get my point. Partly playing devil's advocate but mostly just unsure of the objectives/mindset of investors.

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Aug 1, 2018

Could not agree more. I wouldn't be paying these guys to hedge against the market... I would be paying them to, the vast majority of the time, beat the market; they're supposed to be able to be better than most at making educated guesses regarding which way the market is heading.

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Aug 1, 2018
MichaelScarn:

Could not agree more. I wouldn't be paying these guys to hedge against the market... I would be paying them to, the vast majority of the time, beat the market; they're supposed to be able to be better than most at making educated guesses regarding which way the market is heading.

You're approaching this from the wrong angle (imho). When we put together a portfolio of hedge funds for a client, this is a pretty common misconception that we have to push back against.

Yes, you are paying them to hedge against the market. That is the nature of a hedge fund. We do not look to beat the market all the time, rather we aim to slightly underperform rising markets (due to their hedging and lower betas) and significantly outperform falling markets (again, due to hedging and idiosyncratic positions). Generally, our HF programs run a 70%/20% up/down capture of global equities. In essence this means we look to capture 70% of the returns as markets rise, but only experience 20% of the losses when markets are down. The expectation is that over time (ideally a full market cycle), your hedge fund portfolio will have produced a return similar to, if not better than global equities with significantly less vol

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Aug 1, 2018

This is incredibly useful information -- I did not know that the main goal of (most?) hedge funds is to limit losses in downturn, at expense of beating the S&P in up markets. I'd love to get the stats on what percentage of hedge funds are successful at beating market averages in a downturn... and if this strategy is superior than to just keeping a portion of your money in cash so that you can invest in lower prices during a bear market.

Aug 1, 2018

It depends on the investor in question. The type of person who invests in a fund of funds or bespoke HF portfolio (UHNW, foundations, pensions, etc), generally can't or won't sit on cash in the hopes of buying low. Additionally, they hire people like my firm to allocate capital as best as we can so that they don't have to worry or even really know in depth about when/how to invest

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Aug 2, 2018

Got it. Yes, makes sense that people who pay these funds to manage their money are doing so just for that reason -- to have someone else manage their money. I suppose based on their past performance, investors are putting their trust in the funds for future performance. But I'm just wondering -- and there's probably no answer to this -- if these fund managers' past success is frequently just luck; after all, if you can't outperform consistently, or "most of the time," I wonder if this is indicative that you don't have a system or insights that can beat the market most of the time, and that perhaps you just -- for a certain stretch of time -- got lucky.

Aug 25, 2018

Are you looking to hire?

Aug 14, 2018

I see OP's point. Yes , hedge fund serves to hedge. You're forgetting the model of Ackman's fund, however. Pershing is an 'activist'/ value investing fund. You don't engage in value investing to protect assets, let alone get on the board and go on a borderline PE operation to revamp growth in companies which you own a large stake. They are clearly chasing returns, and doing a damn terrible job at it.

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Aug 16, 2018

Total BS that you tell clients on a losing year. By that same logic, why not just buy a low volatility S&P ETF or a dividends S&P ETF. You'll also track less gain in a rising market and less loss in a falling market. You don't need a hedge fund to easily invest in a lower risk profile.

It again MUST come back to whether you can beat an index like low volility ETFs to prove your worth. If you can't, then it's a waste of money.

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Aug 16, 2018
NoEquityResearch:

Total BS that you tell clients on a losing year. By that same logic, why not just buy a low volatility S&P ETF or a dividends S&P ETF. You'll also track less gain in a rising market and less loss in a falling market. You don't need a hedge fund to easily invest in a lower risk profile.

It again MUST come back to whether you can beat an index like low volility ETFs to prove your worth. If you can't, then it's a waste of money.

Low volatility ETFs are still very high beta. Any long-only basket of securities will naturally be very high beta. A low vol etf will still have large drawdowns in a financial crisis. Broadly speaking, hedge funds as an asset class will not. That is why you see many hedge funds have (even funds that are not beta neutral) completely opposite performance of the market. Even if you are a terrible long-only manager, it's very difficult to lose money in a rising market.

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Aug 17, 2018

BS that we tell clients what, exactly? That their portfolio of hedge funds didn't match the S&P's 22% return or the ACWI's 24% return in 2017? How are the underlying funds supposed to do that when they're running between 50-200% of short exposure, and the market is going straight up?

A point that you missed/I maybe didn't fully flesh out is that most funds do not/cannot try to always crush the index. The vast majority of hedge funds try to make their gains in the long term by minimizing their losses and significantly outperforming indices when shit turns south (i.e. when the S&P is down 37% in 2008, our hedge fund portfolios were only down 12% net of our fee), as a function of their exposure management and hedging. This is why we look to outperform an index over a full market cycle, not beat an index when its on a ridiculous 10 yr bull run. If hedge funds tried to consistently beat the index and maintained high long/net exposures, then an index would be a good benchmark, but they would get very likely shafted in a downturn

Aug 18, 2018

NoEquityResearch,

You should note the large numbers of knowledgeable people posting in this topic who disagree with you, and rethink your position.

There are appropriate benchmarks and metrics for hedge funds. No one here would argue otherwise. But they vary based on the strategy and the objectives.

If a fund invests in stocks but consistently maintains a beta of 0.5 as part of its mandate/strategy you could compare it to a beta-adjust stock market index.

If a fund is consistently market neutral your benchmark should probably be treasuries + some fixed amount (which would vary based on leverage/volatility of the strategy).

If a fund is a long-only (or mostly long-only) concentrated value or activist fund like Pershing Square, the S&P 500 or a global index like MSCI ACWI is an appropriate benchmark.

For all funds, you would want to look at some sort of risk-return metric, in particular the Sharpe ratio. Other risk metrics will be useful as well. Benchmark selection needs to be based on mandate and universe. If your mandate is to "beat the market" then you should be compared to a standard index like the S&P 500. If your mandate is to generate market-uncorrelated positive returns then you should be judged based on your ability to limit correlation with the S&P 500 while generating positive returns. A fund's success in fundraising will be based on how useful it's mandate is to clients and how successful it is in achieving that mandate.

There are lots of ways to measure hedge funds, but generally a mindless use of the S&P 500 is a poor choice.

All that being said, I will say that I get a bit annoyed by long/short equity funds that constantly vary their beta exposures, and run anywhere in the .3 to .7 exposures. As a financial product, such a fund is very clumsy to use, and difficult to measure and benchmark over time. It's difficult to see how such funds fit into a portfolio, even if they have a track record of generating alpha over time. And such funds make up a fairly large portion of the universe of long/short equity funds out there.

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Aug 18, 2018
Markov:

NoEquityResearch,

You should note the large numbers of knowledgeable people posting in this topic who disagree with you, and rethink your position.

Actually, the billions upon billions of dollars leaving managed funds agree with me. Money talks. Like I said before, regardless of the metric, investors are not happy with the performance as shown by the massive outflows.

Secondly, there is a literally a mountain of academic research that shows active managers on average do not beat the index across strategies and asset classes. So the data over decades and the academics also agree with me.

So sorry that I don't respect the opinion of a few self-interested buy side analysts on a message board trying to justify their own jobs.

The fact that you guys get so red-faced about this kind of says it all.

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Aug 18, 2018
NoEquityResearch:
Markov:

NoEquityResearch,

You should note the large numbers of knowledgeable people posting in this topic who disagree with you, and rethink your position.

Actually, the billions upon billions of dollars leaving managed funds agree with me. Money talks. Like I said before, regardless of the metric, investors are not happy with the performance as shown by the massive outflows.

Secondly, there is a literally a mountain of academic research that shows active managers on average do not beat the index across strategies and asset classes. So the data over decades and the academics also agree with me.

So sorry that I don't respect the opinion of a few self-interested buy side analysts on a message board trying to justify their own jobs.

The fact that you guys get so red-faced about this kind of says it all.

Nope, actually according to HFRI, in Q1, net inflows were $1.1bn. Total capital is at a record level (>$3 tn). Just this quarter, D1 capital did a record cap raise for their fund. Sure, the industry may be oversaturated, but to say that theres billions of dollars leaving is false.

I agree with your second point, and I think this is a function of the industry being crowded and thus the averages being diluted by subpar funds. There are still many many managers which perform very well (Elliott, Viking, Tudor, Anchorage to name a few big boys), and part of the challenge is digging through tons of funds to find the best place to put capital. Your point seems to essentially be "on the average, performance is subpar, so the entire industry is shit," which is a bad take.

It seems like you are equally self-interested (see "No Equity Research") against active management. I'm also not red-faced at all, just trying to engage in discussion

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Aug 18, 2018

NoEquityResearch,

A few points.

First, as others have noted you seem to have conflated broader active outflows with hedge fund outflows. Hedge fund flows have been generally positive, and industry AUM is at all time records. I expect those flows will gradually stabilize and potentially turn negative; the hedge fund industry is mature at this point. But there's been no trend toward outflows yet.

Second, I don't think anyone is particularly angry or upset here. But you're getting a lot of really solid commentary in this thread on how the hedge fund industry is measured and evaluated, and how the industry markets itself and how it is seen by potential investors, and you don't seem to be absorbing it or to be aware of your own blind spots. Take a closer read; there's a lot of good content here from a variety of knowledgeable sources. It's clear from your posts that you aren't that close to the industry and that's fine, but this is a moment to learn.

Third, I actually think there are plenty of worthwhile critiques of the hedge fund industry. Cliff Asness, a well regarded financial economist and the founder of asset manager (not hedge fund manager) AQR, was quoted elsewhere in this thread laying out well-thought-out criticisms of the hedge fund industry that I think would get little to no pushback from industry veterans. The crux of his argument is that hedge fund alpha, properly measured, has been very weak to non-existent in the last 3 or so years (I believe it's 3 years; I don't remember the exact timeline). That's fair! It's a valid critique. It's done using the right data and with appropriate analysis. And over time if that trend doesn't reverse, it will lead to outflows (which might or might not restore the alpha). He also, elsewhere on the AQR site (which is worth a read), argues that much hedge fund alpha is replicable cheaply and systematically. That argument is pretty self serving, as AQR markets a lot of cheap systematic strategies that attempt to replicate hedge fund alpha. But the argument also has a fair bit of validity. Anyone who posted those sorts of arguments against hedge funds would get a warm and thoughtful reception on this forum. People aren't blind to the problems with hedge funds here; they just like to discuss the real problems, not the made up ones.

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Aug 1, 2018
LeveredBetaBoy:

I fully understand you shouldn't benchmark hedge funds to the S&P. This said, in the '16-'18 market where you could literally throw a dart and pick a winner, how do you say to investors "look guys, I understand the market is up 20+% and we're down 5%, but you have to understand that we're a non-correlated asset class designed to cushion your overall portfolio on the downside." I'm not expecting outperformance during bull markets because I'm paying for that downside protection, but at what level of underperformance do you say enough is enough, literally holding cash is a better risk adjusted return than being in this fund. Hyperbole obviously but you get my point. Partly playing devil's advocate but mostly just unsure of the objectives/mindset of investors.

Right, that's fine. Most investors are in it for the long haul. But the benchmark that institutional investors look at when it comes to HFs is cash/3m T-bills. Again, I have no specific opinion about Einhorn or Ackman and if they do continue to severely lose money like this, they will probably have to shut down. But they could very easily pick back up. Different macro environments are suitable to different investing styles.

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Aug 14, 2018

@traderlife mentioned this below, but I'd love your thoughts on this too. Not just Einhorn/Ackman, but the entire class of activist investors -- do you think they're staying market neutral? I'm with @traderlife that they aren't, and if so is the TBill + 400bps benchmark still appropriate?

Thanks for your views, always learn a ton from them!

Aug 14, 2018
canas15:

@traderlife mentioned this below, but I'd love your thoughts on this too. Not just Einhorn/Ackman, but the entire class of activist investors -- do you think they're staying market neutral? I'm with @traderlife that they aren't, and if so is the TBill + 400bps benchmark still appropriate?

Thanks for your views, always learn a ton from them!

I'm not an activist guy obviously and yourself and other posters have correctly pointed out that neither Einhorn nor Ackman are likely to be truly market neutral. However, the only truly market neutral funds are quant funds and multimanagers that have a risk team that controls exposures. Hedge funds like Einhorn/Ackman, as I said, likely have a beta component. So, maybe TBill + 400bps might not be the right benchmark.

Regardless, that still doesn't mean SP500 or any other equity index is the right benchmark. I don't know enough about the performance fee structure of activist funds to be able to comment truly on what the benchmark is or should be.

Einhorn and Ackman, overall, have done incredibly well, and I believe both of their annualized returns exceeds the SP. They're billionaires after all. But their success doesn't mean that they should be benchmarked against long-only indexes.

I think there's this issue where because Einhorn, Ackman and other hedge funds are stock focused, it's appropriate to compare them to the major indexes, either formally on a performance fee basis or casually on a forum. I think this reflects a deep misunderstanding of the purpose of hedge funds both among the general public as well as finance professionals who don't work at hedge funds or in asset management.

As I mentioned in another comment (I think), Einhorn and Ackman take very concentrated positions. It's no surprise that there returns could be all over the place. The SP500 is mkt cap weighted of 500 stocks. Ackman might have what, 10 or 12 positions? Silly to benchmark to SP. What should the benchmark be? I'd be curious to hear more about how Pershing/Greenlight structure their performance fees. Perhaps I was overzealous in saying that Ackman/Einhorn should be benchmarked to the T-Bill. Idk what the benchmark truly should be or what it is. It's easy to hate on Ackman and Einhorn for doing shitty the past few years but think about what kind of positions they are taking. They're very risky bets. They aren't highly optimized 200 long/200 short quant funds where you have like 3% unlevered annualized volatility. When you have that kind of strategy, it's probably not unusual to have some big drawdowns like what they're seeing.

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Aug 1, 2018

I wasn't implying that people should put ALL of their money in an index fund. What I meant was, for the money that people have earmarked for stocks, it seems like these billionaire hedge fund guys don't give you much of a chance of consistently beating the market. If you want a hedge against market going down -- depending on your age, of course -- put 50-80 percent of your money in an index fund and put the rest in cash... this way, if market goes down, you have 20-50 percent of your portfolio that wasn't creamed by a bear market and can then be deployed to buy stocks at lower prices.

Aug 1, 2018
MichaelScarn:

I wasn't implying that people should put ALL of their money in an index fund. What I meant was, for the money that people have earmarked for stocks, it seems like these billionaire hedge fund guys don't give you much of a chance of consistently beating the market. If you want a hedge against market going down -- depending on your age, of course -- put 50-80 percent of your money in an index fund and put the rest in cash... this way, if market goes down, you have 20-50 percent of your portfolio that wasn't creamed by a bear market and can then be deployed to buy stocks at lower prices.

"Beating the market" for hedge funds is not beating the S&P. If you are dollar neutral or market neutral, your benchmark is cash or treasury bills. Hedge Funds are not intended in ANY way to be a replacement for stocks. They're actually intended to be more of a replacement for fixed income than anything else. That's how institutional asset allocators look at HFs.

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Aug 1, 2018

Spot on. We compare short term performance to the HFR FOF, Barclays Aggregate, and the MSCI ACWI, but our long term benchmark (and expectation) for our portfolios is T-bills + 4%

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Aug 2, 2018
RunTheJuuls:

Spot on. We compare short term performance to the HFR FOF, Barclays Aggregate, and the MSCI ACWI, but our long term benchmark (and expectation) for our portfolios is T-bills + 4%

It shouldn't be underestimated how difficult a benchmark of T-bills + 4% is to beat if you are dollar/market neutral (same amount of $ in long as in shorts plus no beta exposure). In 2017, I think every sector of the S&P500 was up and stock return correlation was near an all time high. Picking shorts that would under perform enough to get even a 5% return in 2017 was tough.

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Aug 9, 2018

Ackman and Einhorn are not those hedge funds. They are not beta neutral. They are mostly concentrated long equity. A little bit of shorting but there shorts are designed to be alpha not a hedge. And they bet wrong and I thought stupid in real time.

Array
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Aug 20, 2018

This is so stupid it's unreal. Their shit returns are shit on a risk-adjusted and on an absolute basis. Their losses are the result of bad decisions, plain and simple. It has nothing to do with beta. People don't pay asset managers to make objectively wrong investment decisions.

This has to stop. So many HF apologists. If you said this on a job interview you'd be laughed out of the building. Unreal that this is the highest rated comment.

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Aug 20, 2018
Esuric:

This is so stupid it's unreal. Their shit returns are shit on a risk-adjusted and on an absolute basis. Their losses are the result of bad decisions, plain and simple. It has nothing to do with beta. People don't pay asset managers to make objectively wrong investment decisions.

This has to stop. So many HF apologists. If you said this on a job interview you'd be laughed out of the building. Unreal that this is the highest rated comment.

It has everything to do with beta. You clearly do not know very much about the role that hedge funds play from an asset allocation perspective. Nobody is denying that Ackman and Einhorn have had shit returns in the last couple years. On an annualized basis over the course of 15+ years, however, they have been excellent.

How do you define a "wrong" decision? If every sector in the SP500 is up and you don't end up shorting the 5 stocks that were overall down in 2017, did you make a "wrong" decision? No. If your longs outperform your shorts you generated alpha and did your job as a hedge fund.

It's funny because if you talked about benchmarking hedge funds to a long only index, that's what would get you laughed out of the building. Another poster already copied and pasted this but for the love of god, please read this. Cliff Asness is a much smarter guy than me and explains it well.

https://www.aqr.com/Insights/Perspectives/The-Hedg...

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Aug 21, 2018
DeepLearning:
Esuric:

This is so stupid it's unreal. Their shit returns are shit on a risk-adjusted and on an absolute basis. Their losses are the result of bad decisions, plain and simple. It has nothing to do with beta. People don't pay asset managers to make objectively wrong investment decisions.

This has to stop. So many HF apologists. If you said this on a job interview you'd be laughed out of the building. Unreal that this is the highest rated comment.

It has everything to do with beta. You clearly do not know very much about the role that hedge funds play from an asset allocation perspective. Nobody is denying that Ackman and Einhorn have had shit returns in the last couple years. On an annualized basis over the course of 15+ years, however, they have been excellent.

How do you define a "wrong" decision? If every sector in the SP500 is up and you don't end up shorting the 5 stocks that were overall down in 2017, did you make a "wrong" decision? No. If your longs outperform your shorts you generated alpha and did your job as a hedge fund.

It's funny because if you talked about benchmarking hedge funds to a long only index, that's what would get you laughed out of the building. Another poster already copied and pasted this but for the love of god, please read this. Cliff Asness is a much smarter guy than me and explains it well.

https://www.aqr.com/Insights/Perspectives/The-Hedg...

You've already been refuted/discredited yourself with regard to their risk profile. As has been mentioned, they're not beta neutral. They don't try to generate this hypothetical, idealized risk profile that you're obsessed with (and which doesn't really exist and is never actually quantified). In this particular instance, it doesn't describe their strategies at all.

That said, the idea that Ackman intentionally misunderstood Valeant's business model and accounting to obtain negative correlation with an expanding S&P is beyond laughable. Step back for a second and think about what you're saying.

We're not talking about how the HF industry should theoretically operate in aggregate. We're talking about the decisions made by two particular investors.

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Aug 21, 2018

They aren't beta neutral. But the fact that they have substantial short exposure in the first place is important for benchmarking.

Market neutrality is a well defined optimization process. Not sure what you mean by it not existing...

I'm not defending Ackman/Einhorn exactly. At quantitative hedge funds, the objective is to be right on average, not every time. Ackman and Einhorn take highly concentrated positions. They're going to be wrong sometimes and when they are, they'll be wrong in a big way. You need to look at how they do over an at least a 10 year span.

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Aug 21, 2018

Ackman doesn't short much, and he doesn't do it to hedge in any traditional sense. All of his positions are meant to be pure alpha. @Esuric is right that his returns are shit absolute and risk adjusted - its just a symptom of awful decision making.

Einhorn is more of a traditional hedged manager, but far from market neutral. I believe he is not even low net by mandate, which means he has full discretion over how much market exposure to take. No excuse for his performance either except readily identifiable poor decisions.

Some of the points above about hedge funds and market exposure are correct, but with respect to the OPs actual question - Einhorn and Ackman have just sucked. They are kept alive by lockups and LP inertia

Aug 21, 2018

Agreed. Einhorn and Ackman both have poor returns that can't be explained by their beta exposures. Their recent track records are a mess (though both still have strong longer-term records, I believe).

I think Greenlight actually runs fairly tightly hedged (at least some of the time), though Pershing Square, I believe, is almost entirely long right now.

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Aug 1, 2018

Have you taken a look at how some hedge funds have done when the S&P 500 has crashed and compared the two? HFs lost a lot less than someone who placed all of their eggs in one basket and that's the value of hedge funds. They help investors diversify.

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Aug 1, 2018

Are we really on a finance forum and complaining about alpha that hedge funds generate? Like another poster pointed out...generating returns that behave like the s&p500 is not the point of a hedge fund.

Aug 9, 2018

For overall hedge funds you are correct.

For Einhorn and Ackman they are stock pickers. So performing with snp is their job. Those two are not taking away market risks...their funds are meant to pick better stocks.

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Aug 2, 2018

Pershing has a listed vehicle that he raised in his better days. If you read the prospectus you'll see that they implemented a smart draw-down structure. Some guys have long lock-ups and family / wealthy friends usually withdraw last. Once lock-up periods expire, outflows start and given the performance there will not be any inflows unless they raise a new "strategy" fund with a different title. To be frank, institutional money (insurances etc) is not the smartest capital, so guys like DE and BA will always attract some capital.

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Aug 2, 2018

It's a fair question, but at the risk of sounding like a dick, the word hedge is in the name, what's the confusion here ( I assume it has something to do with the youthful naivety of some of this site's users, which is fine). It's a piece of the investment portfolio pie, you're not parking your entire life savings there hoping for an early retirement.

It's basically Blackjack insurance.

Aug 3, 2018

What's the outlook for analysts who work for these firms that have suffered from performance/outflows? Would something like that be held against them during recruiting or would the fund name still carry weight?

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Aug 21, 2018

Big name is a positive regardless. At funds like these analysts don't make decisions anyways, they analyze. The fact that they could get those jobs speaks more to talent than the fact that the funds sucked.

Completely different story if you worked for some small fund that got killed

Aug 6, 2018

I feel like an investment in a hedge fund is all about taking lots of small losses and a few large gains.... whereas more mainstream forms of investment are about taking lots of small gains and a few large losses. Positive skew vs. negative skew in statistics terms.

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Aug 9, 2018

Really? The average investor taking a few large losses? Maybe. Of course, losses on a particular stock can be limited with a stop-loss order.

Aug 9, 2018

I'm saying in general that's the objective of a hedge fund and its value proposition to the markets.

In regards to stop-losses, who do you know that slaps stop losses on each position everyday? You would have to have a hell of an advisor and trading team behind you, especially if you have institutional sized positions.

In fact, don't you think this is the very thing that "hedge" funds do? Manage money, professionally, using all available resources.

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Aug 10, 2018

I believe you're right that most individual investors (probably 95 percent) don't implement stop-loss orders. I was talking in theory, but in reality, yes, most investors subject themselves to significant losses. But I"m talking about if you're about to invest money in a hedge fund, you're clearly somewhat sophisticated -- so if preventing significant loss is whats you're worried about, why not save the 2-and-20 and just implement stop-loss orders? This way, you get the gain of an index and know that, with any particular stock, you can't get crushed. Hurt? Yes. But lose 50 percent of any investment? No, the stop-loss will prevent that.

Aug 10, 2018

Many of these fund managers capitalize on their momentum by raising permanent capital or reinsurance vehicles. These vehicles provide them with a base of capital that is perceived as permanent. It's a nice recurring revenue stream!

Some examples:
* Bill Ackman has Pershing Square Holdings
* David Einhorn has Greenlight Re
* Dan Loeb has Third Point Re

DYEL

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Aug 11, 2018

Many consultants who recommended these guys are like Einhorn and Ackman themselves stuck in GM and HLF.

They were already getting questions from end clients a few quarters into the underperformance. They probably said "trust us, trust Einhorn and Ackman, they will turn it around."

They are touting the same message today several years later. They have no other option. If they reverse course they admit that they were wrong and probably lose the client (certainly the client's trust).

The other thing I'd say is that I suspect that Einhorn and Ackman, when sitting across the conference table, present a highly compelling defense. Both are very bright with charisma and conviction. Wavering investors can be swayed by such personalities.

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Aug 14, 2018

https://www.wsj.com/articles/billionaire-investor-...
the onslaught continues...an article recently that even einhorn's son asked him "daddy, why can't you just short your longs and long your shorts to fix this?"

Aug 14, 2018

Ackman will be back in in 2019, mark my words. Some of his most important trades are just stuck in limbo at the moment. Can't speak for Einhorn... he really needs a broader value vs. growth pivot which may or may not be in the cards near term.

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Aug 14, 2018

agreed, i think ackman's prospects are much greater than einhorn's. ackman's already turning the corner, being up 12% or something like that YTD as of june 30. as for einhorn, as previous posters have alluded to, you don't have to be a growth investor to know not to short amzn...between his inability to embrace garp stocks, his hard partying as featured in wsj recently, etc. i foresee his aum shrinking dramatically in the near future

Aug 16, 2018

While I always recommend for people to just put their money in an index fund and forget about it, you can't look at 2-3 years of data and make a conclusion that people are fools for investing in them. It makes more sense to look at the lifetime returns of the firm or of individual investment vehicles the firm ran and then use that for a more objective opinion. If they sat there making predictable, positive returns every year, regardless of the market, they wouldn't be a hedge fund, they'd be a Ponzi scheme

Aug 21, 2018

No but you can look at a decades worth of data i.e. the Buffett bet.

Aug 28, 2018

This is a different conversation. The Buffett bet is comparing a basket of hedge funds versus the market. Again, I say put money in market with close to no fees over HF 99% of the time for 99% of the people. My point above still stands about 2-3 years not being enough time to evaluate one HF manager (same notion applies to a HF that has outperformed for 2-3 years).

Aug 28, 2018

Ok but definitionally, hedge fund managers are the high priests of finance...

So it stands to reason that over a longer time horizon - like you suggested - such as 10 years, a basket of HF's (selected BY a well known hedge fund manager!) should outperform a group of mindless index drones... no?

Aug 29, 2018

Depends whether or not you believe in the EMH. Personally, I would bet on the market. The only talent you truly need to run a hedge fund is being really good at convincing people to give you money.

Aug 16, 2018

I' having a bad August as well David. We'll be fine.

Aug 16, 2018

From The Hedgie in Winter by Cliff Asness:

"Comparing hedge funds to 100% equities is flat-out silly.
Hedge funds have historically, rather consistently, delivered equity exposure (beta to my fellow geeks) just under 50%. In fact much of their point is, supposedly, to be different from equities. I mean that they are at least partly hedged investments. Put more bluntly, it is in the freaking name!"

"Over the full 20+ year sample, hedge funds have handily outperformed their exposure to the market (that is, the blue line ends substantially positive)."

"Conclusion

The reason to worry about hedge funds is decidedly and emphatically not that they've failed to keep up with 100% long stocks in a nine-year bull market. That was utterly predictable given a strong bull market. The legion of commentators effectively making this fallacious argument must now stop. I'm absolutely convinced that since I've finally explained it so clearly this time that they finally will cease.

But all is not well, and winter may indeed have come to hedge funds. The reason to worry is the evidence, from both their realized excess (vs. their positive beta) returns and, importantly, their correlations to traditional active stock picking, that hedge funds no longer are what they once were. There are no proofs above, just stories and supportive data. But I find the story that hedge funds as a whole are now much closer to regular old traditional active stock picking, and thus less special than before, quite plausible. Given traditional active stock picking is such a consistent long-term disappointment, this ain't good."

MichaelScarn:

And if you had millions to invest, why the hell wouldn't you just put it in a Vanguard Index fund instead of with them?

Source:

"Passive investing would be in trouble had central bankers not decided to directly intervene in equity markets after the financial crisis. Passive investing is a scheme where an investor and a fund management firm both profit without doing anything related to market timing. This induces moral hazard as more investors want large returns by going passive and more fund managers realize large fees while not taking any forecasting risks. If markets fall, they can always blame the economy and the government but not themselves. A more serious side effect of passive investing is that both good and bad companies are rewarded by passive investors and that creates economic excesses that must be painfully removed at some point in time.

As the passive investing trade gets crowded, risks increase. The more people that park their money waiting for returns, the larger the market drop will be next time there is an unpredictable event, as most of these investors usually pick bottoms to get out instead of tops. Few passive investors have the discipline of staying invested along corrections and much fewer engage in bargain hunting near bottoms. Most investors want to get out when a sharp decline occurs in fear of losing everything."

"This chart is even uglier than it looks. A Monte Carlo simulation based on equity curve changes in the daily timeframe generated the following cumulative distribution of maximum drawdown.

"There is 50% probability (loosely speaking) that the drawdown will be larger than 45%. There is probability of about 15% for a drawdown of 60% or larger. This is not an easy ride as seeing a passive investment in S&P 500 losing half of its value is a coin toss based on past history and assuming it is a guide for the future."

cc: @DeepLearning

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Aug 16, 2018

Who cares about beta?

I repeat: who cares about beta? Monte Carlo simulations? This is finance.

and LOL at "Passive investing would be in trouble had central bankers not decided to directly intervene in equity markets after the financial crisis." So if things had been different, things would have been different? Great insight Cliff!

And any smart hedge fund manager should have known the Fed was going to intervene, it's essentially enshrined in law.

Aug 16, 2018

Agree with Cliff here.

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Aug 20, 2018

Of course you do.

And whomever keeps throwing monkey shit, state your case. Most hedge funds add negative value,

"Yes Mr. LP, we've under performed the market over the last decade, but look at this sharpe ratio! NO BETA!!!! We're the kings of risk adjusted return!"

Volatility does not equal risk.

Aug 21, 2018

"The reason to worry about hedge funds is decidedly and emphatically not that they've failed to keep up with 100% long stocks in a nine-year bull market. That was utterly predictable given a strong bull market. The legion of commentators effectively making this fallacious argument must now stop."

This is retarded.

If it was UTTERLY predictable, why would anyone stick money in a hedge fund? If it was predictable than there was zero risk, and the "risk adjusted" reason for using a hedge fund holds no water.

And I'm sorry, but losing to the S&P for A FULL DECADE is inexcusable.

Seriously, who buys what these guys are selling? I swear the quant HF space is full of iq 145+ people with zero common sense.

Aug 21, 2018

I take it there's no reason to ever buy bonds then? They consistently under-perform equities over long time horizon. Only an idiot would buy them?

This is portfolio construction 101. The goal is diversification, not "beating the market". If you want higher returns, you use leverage on an efficient-frontier portfolio. The most valuable thing an asset can add is uncorrelated positive returns, not absolute returns. You don't pile more assets into the highest volatility/highest return asset out there. You maximize the risk/return of your portfolio.

Let me give you a counter example to your argument that only an idiot would invest in assets that underperformed the market: let's say I created a simple fund that just made a levered bet on the market, and thus had a 1.5x beta, One could easily predict, in advance, that if the market shot up for 10 years then my fund would outperform the S&P. And indeed it would have over the last 10 years. Would only an idiot invest in the S&P instead of my levered fund? Of course not. Risk matters. Correlation matters.

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Aug 21, 2018

Ceteris Paribus, - would you rather have an asset that pays you $10,000 per month, every month, like clockwork, for a total of $120,000 per year, OR an asset that pays you a random amount of money every month, for a total of $200,000 per year?

Where in that post do you see anything about portfolio optimization?

I said that Cliff's comment is ridiculous, and it is: if it is "utterly predictable" that strategy A is going to beat strategy B, then what possible reason could anyone have for choosing strategy B?

Of course bonds can make sense, but the goal is not "diversification" - the goal is to maximize returns while minimizing risk, but volatility =! risk. I still don't understand why people have such a difficult time grasping this concept.

Volatility CAN be risky, but in and of itself volatility does not equal risk.

Aug 21, 2018

LOL!

In modern portfolio theory, risk is DEFINED as volatility.

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Aug 21, 2018

Yeah, and LOL I think that "theory" is fundamentally wrong.

"Now, under the whole theory of beta and modern portfolio theory," Buffett said, "we
would have been doing something riskier buying the stock for $40 million than we were
buying it for $80 million, even though it's worth $400 million - because it would have
had more volatility. With that, they've lost me." - Warren Buffett

"I find it preposterous that a single number reflecting past price fluctuations could be thought to completely describe the risk in a security. Beta views risk solely from the perspective of market prices, failing to take into consideration specific business fundamentals or economic developments. The price level is also ignored, as if IBM selling at 50 dollars per share would not be a lower-risk investment than the same IBM at 100 dollars per share." - Seth Klarman

How does this not make sense?

Aug 24, 2018

I'll throw my hat in the ring here. The reason low volatility, low correlation asset classes (bonds) are useful as investments is because when you combine them with other asset classes (equities), you achieve improved risk adjusted return.

Yeah, you can't eat risk adjusted return. If you want the most money at the end of the day and can invest in a strategy making 7% while the market makes 10%, all else equal you'll be 100% in equities. Importantly, though, the stocks/bonds strategy will have much lower volatility, and relatedly, much lower drawdowns. (Actually by this logic you should be in 200% equities)

But crucially, if you use leverage to invest in the same ratio of stocks/bonds that yields a 7% return with low drawdowns, you can expect (these numbers aren't exact they just illustrate the point) 12% returns, still with lower drawdowns than the market.

That is why it is useful to invest in funds that have low correlation to other asset classes. If a hedge fund has low correlations to stocks, bonds, commodities, etc, all it has to do to be successful is earn above the risk free rate because it is valuable as a diversifying asset.

Again, the buyers of these funds will now have an asset in their portfolios that will improve their overall portfolios in the sense that they will be able to use more leverage to achieve greater returns with less drawdowns.

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Aug 21, 2018

There's so much wrong here it's hard to know where to be begin.

First, on voliatility and risk:
http://www.pmjar.com/?p=1778
As usual, Cliff says it better than I can.

But secondly, you've badly misread Cliff's point about the underperformance being predictable:

The reason to worry about hedge funds is decidedly and emphatically not that they've failed to keep up with 100% long stocks in a nine-year bull market. That was utterly predictable given a strong bull market.

That's his point: not that hedge funds will always underperform, but that they will always underperform a bull market because their beta is considerably less than 1. In any raging bull market high beta assets outperform the markets and low beta assets underperform. Hedge funds are low beta. This isn't rocket science. The reason to invest in hedge funds isn't, though, that they outperform in bull markets or in bear markets or whatever, it's the prospect of finding differentiated, uncorrelated sources of return, or alpha. And you can have massive alpha even if you underperform bull markets. It's all relative to beta. The question is never about out-performing or under-performing the stock market. It's alpha, alpha, alpha. All valid criticisms of hedge funds focus on declining alpha over the last few years (a real issue!!). None focus on how they perform relative to the market.

People invest in hedge funds for differentiated sources of return, not because they outperform bull markets. It's the same reason people add bonds to their equity portfolio. It's not about maximizing returns, it's about maximizing sharpe ratios. If you want to maximize returns, you use leverage on the most efficient portfolio.

You're deeply confused about this stuff, and it's worth learning more, rather than just rejecting what you're reading here. I assure you that Warren Buffet, for instance, understands what I'm talking about perfectly and implements it incredibly well. He never invests in the highest return assets. He invests in a lot of stuff where, in a bull market, under-performance would be "utterly predictable." Lots of his bets have been very low beta, and thus have under-performed bull markets. He's compounded at 20% for a lot of reasons, but an absolutely key one is is that he built well constructed portfolios, with low underlying volatility, and then added a ton of leverage using insurance float. The leverage generated the returns.

Good portfolio construction is incredibly powerful, and finding diversified sources of return is extremely valuable in that context.

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Aug 21, 2018

I know what Cliff was trying to say, I was making my own non-sequitur to highlight the absurdity of his post.

In the link you provided, Cliff steelmans his own position by NOT referencing beta...

And volatility isn't how much the security is likely to move; it's how much it's likely to move versus the forecast of expected return.

... and strawmans the opposing argument:

The critics are usually envisioning an overvalued security (which, of course, they assume they know is overvalued with certainty) that possesses a low volatility.

All valid criticisms of hedge funds involve paying too much and getting too little in return. I don't think smart investors should look to maximize sharpe ratios. I don't think CAPM is valid.

I'm sure that Buffett does understand what you're talking about perfectly, but I disagree that he seeks to implement it; he is size and politically handicapped now - his very best years came during the time of his partnership.

Good portfolio construction is incredibly powerful, but I think offerings from guys like Cliff are terrible relative to other options (HF's like Spitznagel, certain bonds, private businesses).

We might just agree to disagree...

Aug 21, 2018
CuriousCharacter:

Ceteris Paribus, - would you rather have an asset that pays you $10,000 per month, every month, like clockwork, for a total of $120,000 per year, OR an asset that pays you a random amount of money every month, for a total of $200,000 per year?

Where in that post do you see anything about portfolio optimization?

I said that Cliff's comment is ridiculous, and it is: if it is "utterly predictable" that strategy A is going to beat strategy B, then what possible reason could anyone have for choosing strategy B?

Of course bonds can make sense, but the goal is not "diversification" - the goal is to maximize returns while minimizing risk, but volatility =! risk. I still don't understand why people have such a difficult time grasping this concept.

Volatility CAN be risky, but in and of itself volatility does not equal risk.

The portfolio optimization/volatility/beta discussion stems from (imo) the fundamental disconnect between most of the pro-HF and anti-HF people in this thread. We view hedge funds as an asset class, and as such when built into a portfolio, they offer a number of diversification benefits as a result of their low correlation, risk profile, and factor exposure relative to other asset classes. They are not meant to be an alternative to traditional long only equity allocations, because they utilize several different things; alternative risk premia, uncorrelated/absolute returns, low volatility, and low beta to name a few. This is where the HF value proposition lies.

Aug 22, 2018

I don't see how anyone can view a hedge fund as an asset class, that makes no sense.

You sound like you're parroting back a hedge fund brochure. Hedge funds are designed to make money.

I wonder how the conversations go with LPs after a full decade of losses.

LP: "You fucking idiot! I've paid a 2% management fee for the privilege of losing 5% every year for the past 10! Explain yourself!"

Quant PM: "But we're completely uncorrelated with the market! And we have THE LOWEST BETA in the industry! Zero volatility!"

Aug 22, 2018

What is your reasoning behind your assertion that hedge funds are not an asset class, other than it "makes no sense"? If they offer different risk/return profiles and risk factor exposure than equities, bonds, or cash, then they should be treated as such, no?

I understand that hedge funds are designed to make money. What you seem to ignore or fail to grasp is that their goal (and thus the more appropriate lens to view them through) is outperformance over a full market cycle, not a 10 year bull run.

After a decade of losses, a fund would be shuttered. In a decade of underperformance (which is what I think you meant), yes those metrics become important because they are indicators of how the fund is positioned. And the majority of LPs understand and tolerate moderate underperformance relative to equities (but are not thrilled, of course) because they understand that the CAPM/MPT implies that a low beta, uncorrelated strategy (which is what HFs are) will of course underperform a market which is going straight up with historically low dispersion and volatility. If the fund consistently and widely underperforms equities, then the GP will be in the hot seat, but to argue that funds and the whole industry is worthless because their hedged strategy didn't match a 100% net long equity index on a bull run is ridiculous.

Aug 22, 2018

My reasoning behind my assertion that hedge funds are not an asset class is that hedge funds are not an asset class...

Hedge funds are a vehicle for investing in assets, they are not an asset class in and of themselves. For example, you mentioned index funds... index funds are not an asset class, the equities underlying them are.

"a low beta, uncorrelated strategy (which is what HFs are)" this might be true for some hedge funds, but is by no means true for all HFs.

As I said before, I don't think CAPM is valid, and I don't think that beta is necessarily a good metric.

I didn't say that the whole industry was worthless. I said that most HF managers aren't worth the fees. I also said they introduce unnecessary complexity to justify their existence (alpha, beta, CAPM, and a myriad of other esoteric terms) and underperformance.

Aug 24, 2018

To be fair, hedge funds didn't invent these terms. The academics that invented them would probably agree with you that hedge funds are useless!

Aug 24, 2018

You are way out of your element it's laughable.

Never quote Buffett. He's a genius but a charlatan in some of his public comments. He's not the most honest man around.

Some hedge funds really are an asset class of their own. They are arbitraging and picking up timing features of markets and really shouldn't have much market risks. Millennium is a great example. They are really just a bunch of swing traders and day traders at gigantic scale. The firm lost like 3% in 2008 and every other year up. So for zero beta and beating a bond index that fund doesn't compare to an equity or bond.

The asset they are providing is market liquidity. If someone else needs to sell they were either smart enough to sell before or are buying a cheap price across thousand of markets. Their asset class is trading not equity or bonds. A true hedge fund is really a third asset class. Especially with no more bank prop desks it opened a place for them. Global markets need liquidity and their asset is liquidity.

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