Hedge Funds Faced Choppy Waters in 2015, but Chiefs Cashed In
nytimes.com
nytimes.com
I did IT at a Wall Street investment bank. Jim Simons and these math and CS guys at Ren Tech made a paradise for math and CS people over there. At investment banks you make money for heirs, and as IT are treated like garbage, and their IT and quant operations are garbage at investment banks (relative to hedge funds). Rentech, DE Shaw etc. did quant math, IT infrastructure etc. right and are kicking investment banks ass. Rentech manages employee capital instead of handing it to heirs and underpaying IT and treating IT like shit and having a shitty IT infrastructure like even the top investment banks often do. So these hedge funds are demonized by traditional Wall Street, who are trying to hang some populist halo around the criticism. It would have to be a populist or liberal/soc-dem criticism, because it's certainly not some kind of Marxian criticism. Marx explained how exploitation happened in capitalism, and it's not by a bunch of machine learning gurus managing their own money figuring out how to trade commodities better than Wall Street investment banks who manage the money of heirs.
These guys aren't sitting around by themselves making money in a vacuum, they're also allegedly engaging in illegal and/or unethical financial fuckery, for lack of a better term, and obviously spending money on politicians which may or may not mean anything at all.
http://www.motherjones.com/politics/2014/10/hedge-fund-taxes...
http://www.motherjones.com/politics/2012/05/hedge-fund-hedge...
Before any bias is expressed against motherjones, all I want to say is that these two articles are the only even quasi-critical voices I have seen, which also points out the timing and circumstances that surrounded the publication of the article that enamored me of James Simons: http://www.nytimes.com/2014/07/08/science/a-billionaire-math...
Anyway, everything is grey and nothing is black and white. Just wanted to put something on the other side of the scale.
He's an interesting guy regardless, video interviews with him are often fascinating... and he named his yacht Archimedes.
By the way, want to lower salaries of hedge fund managers? Make great startups that: 1. provide serious automated financial tools for investors; 2. make this financial stuff so that it can be used by everybody on the planet, not only by US currency holders
I'm probably just to poor at economics but if someone could explain the use and benefit to society of these hedge fund managers, that would be great. If they simply extract value by some complicated process of obfuscation, we should vote for a system where they don't exist.
If they aren't making anything of value then why is anyone paying them? Clearly they are making something of value in someone's eyes.
Or by 'making' do you mean literally manufacturing? If so do you not value the work of doctors? They don't produce any goods either.
> if someone could explain the use and benefit to society
Why does everything have to be objectively useful and beneficial to the whole of society? Why can't we judge things based on the simple question of 'is something willing to pay for it with their own money'. Here they are, so it's clearly useful and beneficial to someone.
Scraping makes it sound like they're going out and taking things off people, when in reality they're buying from people who want to sell, and selling to people who want to buy.
You focus on the fact that they make lots of money, where I feel that any ethical argument should focus on the actions, not the sum of money involved. If what they are doing is unethical when they earn a million year, is it still unethical if they earn a median salary instead?
If not, and I suspect that's the case, then it looks just like income jealousy to me.
Does the money purely come from companies that start to do well after initial investment? If so, that is not a bad thing. If it is more of pyramid scheme where many small time players are constantly losing from the big shots that actually influence the market rates because they do such mayor transactions, then it seems unfair. Or just stupid on the small fry side.
Most of what a successful hedge fund does is moving wealth rather than creating it. The people it's moved to will no doubt be very happy to pay for that service, but that doesn't mean any value is actually being created.
Imagine a world where money literally rains down from the sky. Anyone can pick it up and use it to buy things.
But some enterprising people think "Hmm, I bet I can get a larger share of this money". Some of them put up big poles and attach enormous nets to them, collecting money that would otherwise have fallen in other people's gardens. Some buy planes that fly around catching money before it has a chance to land. Some find ways to generate strong winds that blow the money to where they can collect it.
Much competition ensues. Higher, wider nets! Faster planes with broader-area money-collecting apparatus! Stronger winds!
After a while, most of the money falling from the sky ends up in the pockets of a few organizations that can afford (and have the skill to develop) the most effective money-collecting machinery (nets, planes, wind generators) and have managed to negotiate legal rights to collect money falling in areas they wouldn't otherwise have had access to.
They very kindly sell their money-collecting services (this is how they fund the development of better and better money-collecting machinery) and, indeed, they provide good value for money: you can often pay them $1M and get back $2M. They are, that is, providing a service that is valuable to their customers.
But they are not increasing the amount of money falling from the sky. All they're doing is catching it more effectively than anyone else is able to. They do very slightly increase the total amount of money being collected, because their machines can get at a few otherwise inaccessible places, but mostly all they do is redirect to themselves (and their customers) money that would otherwise have ended up in someone else's hands.
A successful hedge fund is a little like one of these money-collecting organizations. It has developed effective ways of making money flow into their pockets rather than others', it provides that service to its investors at a price they are happy to pay, it may create a very little value by increasing market efficiency a bit, but mostly it's playing a zero-sum game.
> Why does everything have to be objectively useful and beneficial to the whole of society?
Clearly it doesn't. After all, we have all these hedge funds, and the people running them and working for them are very nicely compensated for it.
> the simple question of 'is something willing to pay for it with their own money'
If you make that your only question then you end up approving of theft and assassination, both of which are things people are willing to pay for with their own money. Unless you're happy with that, you need some other principles.
In your analogy if they were illegally cutting down other people's nets or illegally breaking their wind machines, I'd see a problem with that.
Just as theft and assassination are covered by the common law.
Otherwise, I understand your argument but just disagree that anything unethical is going on.
The trouble with the second of these, as an ethical principle, is that it offers no way to decide what to make illegal in the first place. Suppose your legal system has carelessly failed to forbid murdering people for money; then doing so meets all of your criteria (people will pay for it, doing it well surely requires an investment of time and effort, and it isn't against the law). Someone arguing against it will have to make exactly the kind of argument you've objected to here: "Murder-for-hire is a bad thing even though people will pay for it, because overall it makes the world a worse place."
You may reasonably be completely untroubled by this if you think your legal system, as it is now, perfectly captures all the moral principles it's reasonable to care about. Personally, I am not convinced that any actually existing legal system does this.
> I understand your argument but just disagree that anything unethical is going on.
OK. How do you feel about the ethics of the situation in my fable? The first person who realised that he could get more money by putting up a big net that extends over his neighbour's garden: anything wrong with that? Are you happy with the final result, where the overall amount of money everyone's getting is the same but lots of people are having to work very hard to make it be them rather than someone else who gets it?
I'm not sure I'd exactly say that hedge funds, or indeed the money-collecting businesses in my fable, are acting unethically. If they didn't do it, someone else would and the situation wouldn't be any better. But I would say that the overall result is a pretty terrible one. What we have here is a coordination problem: you have lots of people acting in individually-reasonable ways, and the overall outcome is much worse than what you'd get if by some magic everyone could agree to act so as to produce a mutually-better outcome. (E.g., just letting the money carry on falling from the sky.)
(The best answer we currently have to large-scale coordination problems is regulation enforced by the government. That has plenty of problems of its own, of course.)
Putting a net over someone's garden, I can see that as an unethical act because it infringes on the other person and my conscience feels bad for the person under the net. Is there a similar concrete action that I can see as unethical in the trader's systems?
Paying a huge sum of money to put machines inside a stock exchange's server room (I think people do that?) so they get lower latency for example. I don't see that as being an unethical act. Both the stock exchange and the trader are entitled to do whatever they want with their own systems in their own buildings, and presumably a fair price is being paid for the privilege. Nobody else's property or quality of life is infringed.
Still, let's see. Suppose a hedge fund discovers a pattern in the trades made by certain large pension funds. (Example: suppose there is some regulation that limits how much of any one asset they can hold at the end of each calendar month, and this leads to somewhat-predictable selling on the last trading day of each month.) They find that they can make money by selling (short if necessary) a lot of these assets the day before, and then buying them back after the pension funds make their trades. The pension fund managers don't have the option of changing when they make those trades, because there's an annoying law restricting what they do. End result: everyone whose pension is in the pension fund ends up just a tiny bit poorer, and the hedge fund is just a bit more successful.
(Who loses? Pension funds; hence, investors in pension funds.)
Or let's take your HFT example (though I think most hedge funds are not in the HFT business and don't really care about shaving a few microseconds off their latencies). So, we have an HFT firm. They pay that huge sum of money to the people who run the stock exchange to get their machines colocated. Now they, instead of their rivals who don't have the colocated machines, get to do all the market-making trades; their trading volume goes up, their rivals' goes down, and they make a pile of extra money. Those few microseconds of lower latency don't benefit the other people they trade with -- they matter only to HFT firms. And their rivals can't make up for it by quoting lower spreads, because prices are quantized and the very small price reduction that would be appropriate simply isn't possible. All that's happened is that our HFT firm has paid a pile of money to the exchange, and now they get to make more of the trades. This is the exact same structure as if they'd bribed the exchange for preferential treatment instead.
(Who loses? Other market-making traders, which pretty much means other HFT firms.)
In each of these scenarios, no one is stealing from anyone else. Nothing illegal is going on. But both of them are zero-sum: our protagonists are making more money and someone else is making less. (Almost perfectly zero-sum. In the first case, the price distortions arising from the pension funds' artificially constrained trades are smoothed out a bit. In the second, people trading with the HFT firm get their orders filled a few microseconds earlier.) Is it unethical, exactly? I dunno, and in any case your values and mine may not coincide. But the pattern each time is the same as when I put up a net that extends over your garden and catches some of the money raining from the sky: I have invested time and effort, with the consequence that I am a bit richer and you are a bit poorer.
How would you go about quantifying that? May it not be the case that gains from market efficiency increases far outweigh the "cost" of hedge funds?
I'm not sure why the scare-quotes around "cost"; there obviously is a cost, typically "2 and 20". So the effect of the hedge fund is: it plays the zero-sum game and thereby redirects money (say an amount x) from a bunch of other market participants; the investors pay their 2-and-20 fees (call the amount c); the hedge fund is doing well and x>c so the investors are happy. Those other market participants are losing an amount x (relative to what they'd have had without the hedge fund) because the game is zero-sum; of course they are not happy, but who cares about them?
(Actually, they might be happy -- the effect the hedge fund has on them is probably small, and if the market is generally doing well they'll doubtless feel fine. But they'll be worse off than they would have been without the hedge fund in the market.)
It's worth being a bit careful about who loses out and how. It typically isn't the other parties the hedge fund trades with. (Consider a case where the hedge fund predicts that an asset will increase in price, buys it from someone else, and sells it later at a handsome profit. Have they harmed the person they bought it from? No; they would have sold it anyway, and they'd have got a lower price for it.) The losers are all the other people who are making trades similar to the hedge fund's, and have to accept very slightly less favourable prices because the hedge fund is making the same trades as they are. So, e.g., if you expect that Apple stock is going to go up and buy some, and if some hedge fund with cleverer people and faster computers and (don't say this too loudly) more inside information has made the same prediction before you did, then you will be paying a higher price because of the hedge fund's activity.
The scare quotes around "cost" are just to underline the negative connotations in the term. If it turns out their are large overall gains from their activity, I feel it would be a bit disingenuous to talk about their "cost" if they're bringing more value to the economy than they're taking away.
Anyway, I don't think your analysis is sufficient to answer my question. There are second order effects beyond what happens to people involved in the trading of securities. Better market efficiency means better pricing of securities, which has effects on the returns of equity financing, which in turn could mean higher growth at a higher level.
To be fair, it's a pretty complex question and I wasn't expecting a precise answer, but references to papers that might have been written on the subject would have been interesting.
because that's a lie? people pay for certain financial services because their options are systematically oppressed. what we're complaining about in this thread is how the structure of the system artifically captures "value".
what would happen if we applied the same simple judgement to heroin dealers? there are clearly many people willing to pay them.
These guys manage money for hundreds of thousands, if not millions of people who are counting on that money being there for their retirement or families.
If a hedge fund manager earns $1 billion, you can be assured that he grew his customers investments by something like $4 billion.
For every guy that makes $1 billion, there are a thousand or more that don't get anything close to the salary that a medium-salaried employee at a decent startup gets because they LOST their investors money.
Given the 2/20 rules that a lot of funds follow, that's not strictly true.
If you're managing a $10bn fund, and working on 2/20 (2% fee, 20% performance), you're taking $200m off the front just for managing the money. Regardless of profit or loss, you've got that money.
You're then taking another 20% off of any profits you're making, when you're making them. And then keeping them even if you end up losing money the next quarter, that money's still yours.
And that 2% is literally for doing nothing then right? You don't make it sound less disgusting now that 'anyone' does that?
Edit: sorry, read another thread of yours that 2% is covering cost; how can it be a % if it is covering cost? Cost goes up when the $ goes up? How does that work? Again, not trying to be annoying here.
> Edit: sorry, read another thread of yours that 2% is covering cost; how can it be a % if it is covering cost? Cost goes up when the $ goes up? How does that work? Again, not trying to be annoying here.
If my business grows, chances are some business-related expenses grow along with it. How is this any different?
So I can't ask? :) Some people here seem to know and I'm interested so I ask? Weird remark as if the number of posts should indicate deep knowledge.
> If my business grows, chances are some business-related expenses grow along with it. How is this any different?
Along with it? There definitely are businesses that grow linear with their revenue but this seems not to be one of them.
> Along with it? There definitely are businesses that grow linear with their revenue but seems not to be one of them.
I don't know what the second sentence of this means. Are you missing a word in there?
And sure, I don't consider shuffling money around in a way that is actually inaccessible to 'normal people' to make rich people richer (obscenely rich) to be something 'good'. That's my opinion and I guess you can read that in my way of saying things. That said, I am interested in it. And what I read about it (which is indeed what I read online) makes me have those opinions and nothing in this thread makes it less rancid so far. But because I have been wrong I read other opinions and explanations.
The word 'this' is missing from the last sentence, apologies, I fixed it. So my question is; if a hedge fund grows from 5 billion to 10 billion it incurs double the cost of operations? Like, for instance, a software services company would do? If not, then why are the fees a % and not a fixed number based on operational cost, unless it's mere easy pocket filling because 'everyone else does it'?
If a hedge fund grows from 5 to 10bn, it is unlikely to be able to continue its current strategy without returns suffering. You can only throw so much money at something before it stops working. As a result, you need to hire more people to manage the additional assets, you need to hire more operational staff to make sure everything runs smoothly, you need to hire additional investor relations staff to attend to your new investors, blah blah.
Management fees are barely enough to keep the lights on for an average sized fund and if you're a new fund, chances are you are waiving some, if not all fees. If I manage $500mm, that's $1mm in management fees (assuming 2% which is a very liberal assumption). If I raised $500mm, investors are going to want to see a COO, CFO, CCO, blah blah blah. Let's say I hire all of those, I'm the sole portfolio manager and I have a single analyst. Between salaries for all those and random incidentals, there's not much leftover from that $1mm in management fees.
For smaller funds I can definitely see this being an issue. Larger i'm not sure still. But yeah, let's not go into that today. For another time.
Also not strictly true. Some of the large funds with (confidence in their ability to perform|managing enough money to not care about massive performance anymore) operate on 1/20 rather than 2/20.
Um, no you can't. A lot of hedge funds don't charge performance-related fees. Some of the best performing managers one year go on to be massive losers in another because they're taking so much risk.
And those funds that LOSE money for their investors also don't MAKE money for their fund managers.
[0] https://en.wikipedia.org/wiki/Income_tax_in_the_United_State...
France introduced a 75% tax in 2012 (or 2013) on income above €1m, and it drove away significant amounts of wealthy residents.
I'm not declaring what the best top tax bracket should be, I'm countering the dismissal of much higher tax brackets as fantasy with facts that they have existed.
Today, many countries in Europe have a top income tax bracket at or above 50% plus a VAT of 20-25%.
http://www.bloomberg.com/news/articles/2013-03-22/the-beatle...
It's in nature of our world that very often good decisions lead to losses.
That they can multiply their earnings over all their customers, and keep this insane income for themselves, is morally wrong and a huge bug in the way the world currently works.
These managers that make billions of dollars - they own their firm. It's a profitable private company, but a company nevertheless. If I own a company with 500 employees making widgets, as the owner, if the business turns a profit, I will collect those profits.
The mere fact that I exist and provide those services is beneficial for society even if I am taxed at 0%.
There are of course issues if I have a monopoly or if I am extracting rent from what should be a common good (say natural resources of crucial piece of land) or if I am polluting while providing my services. There are also issues if what I do hurt others but they are or unrelated to the fact that I create wealth for myself. How is it wrong? What moral principle are you using to say it's wrong? My reasons are quite straightforward: by providing sought for services I am increasing my and my customer's happiness while not hurting others in the process. It's a win-win, the more I provide the more insanely win-win it is even if I collect a trillion dollars in the process.
>>he can afford to control the entire output of a huge number of people over their entire working lives.
That's vast majority of working Americans. Make 100k USD in few years and you are able to control a lot of lives around the world, not only output of their work. Buy a nice car, a Macbook and some clothes and you have just controlled output of more than one whole working life.
Whether this is true or not is highly dependent on a lot of externalities, but I can envision a situations where this would be worth something to a client.
Firstly, financial education. How many asset managers like pension funds want to put part of their portfolios in hedge funds even when their returns are sub-par. The industry is very opaque in terms of disclosing returns, and many indices are biased upward due to survivorship bias.
Secondly, the lobbying to keep the taxes at a low, and other tax loopholes, onshore and offshore, mean that the profits made by the industry are taxed lower than what would be made by a manufacturing firm.
The industry as a whole will never be truly free-market due to many regulations and laws, so your point about having a universal solution for everyone to invest across borders is probably not going to be realized in the next several decades at least.
They got 25 billion dollars from the US government in bailout, then they paid 13 billion dollars as settlement for fraudulent practices pre-2008, and so on and so on...
It's total ridiculous ideological stupidity to say "duh, they earn their money on the free market."
http://www.cnbc.com/2014/05/09/jpmorgan-flagship-hedge-fund-...
Instead, we look at supply and demand. How many people could do a similar job?
It's funny you mention the middle ages, because there are a lot of parallels there, I think. Tax collectors would bring in massive wealth for their employers, but would anyone say that such wealth was fairly and honestly come by? Middle ages governments were rarely consensual and most of their expenditures were not to the benefit of those they ruled. I think if you look at hedge funds you'll see a lot of similarities. A lot of their wealth comes not from investments or from facilitating economic activity. Rather, a lot of it can be characterized as extractive and even exploitative.
Hedge funds are not just about managing huge amounts of wealth, painting them as such is a diversion. They are about using money to extract even more money from whatever "market" it is possible to do so, and at whatever cost.
Worse yet, hedge funds have so corrupted and influenced our governments that they've been able to socialize their losses during economic crashes, without being forced to socialize their gains during booms. Additionally, some of the largest wealth transfers in history are occurring right now through stock buyback programs, which substantially benefit stock owners and especially hedge funds.
Meanwhile, hedge funds are not actually producing substantial returns for their investors, most do worse than index funds. So somehow they manage to be both really bad for democracy, bad for a lot of the things they poke their fingers in (where they look at only the bottom line and attempt to extract the most dollars in the shortest time frame, the worst characterization of the influence of the stock market), and yet they are still bad at providing a decent RoI. But hedge fund managers pay themselves well, certainly. It's little more than the same old problem of oversized corporate executive pay scaled up. Whether they perform well or poorly the refrain is always "oh, but here you are dealing with a different class of people, the CEO class or the hedge-fund-manager class, and they are oh so unusual and special that they demand a higher caliber of pay even when they fail, because you see if you were to get some schlub off the street to do the work they would have cocked it up far worse, so you should be thankful". This despite all evidence imaginable to the contrary. It's simply a matter of elitism and classism run amok, which might as well be a new type of aristocracy.
(As for your last comment, this is already done, the only "automated financial tools" most investors need is an index fund, which not only outperforms almost all hedge funds it also outperforms most other types of active investments.)
To see a better breakdown look at the 2016 rich list at
http://www.institutionalinvestorsalpha.com/Article/3552805/T...
Note the following paragraph:
In a year when roughly half of all hedge funds lost money, a
number of frequent Rich List members are conspicuously missing
from the ranking because their funds finished in the red.
"Mr. Griffin’s firm, Citadel, has grown from a hedge fund that managed family and pension fund money into a $25 billion firm"
"Citadel’s flagship Kensington and Wellington hedge funds returned 14.3 percent over 2015."
It might be true but seems incredible, that would mean he personally took 6.8% of the entire fund's capital as a salary. Not salary of course but carried interest - he only has to pay capital gains tax rate because Wall street.
Also keep in mind that they only get that if they earn more for the investors than the "hurdle rate" which is an agreed upon metric for return.
Quite literally, they only get paid if you do very well in the markets. For every $10 that they grow your money, they keep $2 and you get $8.
True to a degree, unless your AUM is growing substantially faster than your costs, at which point your fees are covering more than that already.
Pension funds are a clear wealth transfer from the working class to HF/PE managers without any benefits to the working class.
Fee adjusted returns are worse than index funds.
HF/PE managers dodge taxes through the carried interest loophole which the "socialist" Obama refuses to close despite having the power to do so without enacting new legislation.
(Making money is great, I don't see anything controversial in it as long as nobody's hand is forced).
The amount of money they earn is arbitrary. If the deal is 2/20, and the manager performs (hence the 20), they're rewarded. That seems fair to me. If you think 20% is too high, find a different fund?
[0] http://www.bloomberg.com/news/articles/2015-12-02/hedge-fund...
Edit. I know snark is not the HN way, but when faced with the total obscenity that is 25 people exploiting pension funds to the tune of $12.94 billion in one year it is more than I can stomach.
So they aren't taking anything from the fund. They are investing the money wisely, growing it, and sharing in the gains. It doesn't get more "fair" than that.
Pensions would also be lower if they were invested in funds that made lower or negative returns. The theory (right or wrong) is that the high fees charged by the hedge funds are justified because they provide better risk-adjusted returns than other investment vehicles. Hedge funds may be bad and their CEOs may be overcompensated, but it is more complicated than just "every dollar paid to Kenneth Griffin is a dollar taken from a pension fund."