Am I seeing it wrong? Is the compensation really for convincing Joe Public to part with his money for a really terrible deal?
[1] https://en.m.wikipedia.org/wiki/Renaissance_Technologies#Med...
There's a lot of survivor bias in the industry. All the old players have made a lot of money at some point. If they hadn't, they wouldn't be old players.
Thus you end up with most companies having an 'above average' streak in a given year even if the average investment does poorly. https://m.youtube.com/watch?v=rwvIGNXY21Y
[0]https://en.wikipedia.org/wiki/James_Harris_Simons#Academic_a...
That's a fair point. I'm not one for argument by authority.
My point with his discovery is that he's empirically demonstrated a capability of uncovering understanding and deep mathematical relationships, which have practical implications. The PHD part is less relevant.
In my opinion, this information decreases the probability that rentech has been consistently outperforming on the basis of pure luck. By how much, though, I can't say.
First of all, you haven't qualified who you're including in the set of "traders" and who you're including in the set of "winners." Is everyone who signs up for ETrade included? That's like major league baseball players being judged the same as way as high school baseball players. More importantly, have you done the cursory research to account for funds that consistently beat the market? How do you account for the firms that beat the market over periods that span decades? Just ridiculously lucky? What counts as a coin flip? A single trade? A trading day? Are the coins summed per trader or per fund? How are we quantifying this assessment?
It's like every time someone brings up the coin flipping analogy they use these outrageous numbers without any attempt at citing a grounded source in reality. As I say every single time in threads like this: yes, it's incredibly difficult to purposefully and consistently beat the market, but that's worlds away from impossible. There is information asymmetry in the market, relatively few people/firms are capable of identifying alpha based on that, and fewer still are capable of capitalizing on it. But they exist!
Stubbornly repeating the coin analogy is like insisting on proof that basketball players have inherent skill instead of luck, because most people can't make it to the NBA. We have clear examples of firms beating the market consistently for decades at a time, net of fees. I am personally familiar with people whose strategies profitably trade on small pockets of predictable events in timeseries tick data. Their strategies are smaller (~high 6 - low 7 digit accounts using personal capital), but they consistently earn 27-30% each year by trading strategies that are too capacity-constrained for larger firms (and usually they do this after being in the industry for some time).
I make this point not to pick on you (it's not personal!), it's just that I see this repeated in every thread related to trading on HN. Referring to trading as coin flipping when your familiarity mostly stems from news reports flies in the face of people who are capable of developing profitable trading algorithms and who have seen it. It's as if someone told you that it's impossible to develop well-engineered software. It's exhausting. There's this weird leap from (correctly) concluding that most people in the industry can't beat the market, to damning the entire concept.
If you want to say there is a lot of survivorship bias in the industry, sure, I'll agree with that. But what's the point of using Fama's coin flipping analogy if there's no rigor behind it? It precludes so much nuance in fund performance. Many funds can't beat the market at all. Many do beat the market, but they purposely decide to eat away all those gains with fees when they could run a far leaner ship. And the elite do consistently beat the market, until they eventually get large enough to diversify into multiple funds (accepting that most will be mediocre) or they return investor money because they don't need it and their strategies are capacity constrained.
Suppose I have a 90% chance of making a positive return in any given year. The chance that I'll make money every year for ten years is about 35%. Over 20 years, it's about 12%.
Now, I don't believe that anyone has a 90% chance of making money in a given year. Even if I conceeded that it's possible to have a long-term edge in the markets, I'd say it's more like a 55% chance of making money. So instead of there being a handful of elite geniuses with a 90% edge, I think it's more likely that there are many smart people with a 55% edge, all tossing coins.
I've hidden a lot of things away in this analysis, and I'd need to write a full essay to give the issue its due. For example, I've ignored the possibility to "beat" the market by leveraging up your S&P exposure and charging fees on top. If the S&P goes up, you beat it. If the S&P goes down, you blow up and start again.
The answer to the theoretical first question might well be "yes, there are exceptional traders outperforming the market". The second "real-world" question is much more involved:
* can I reliably identify them, ex ante? That's pretty hard.
* do I have access to them? Many of the examples cited (Renaissance Tec, individual traders trading personal account) are closed to outside investors. Many golden investment opportunities are channeled to people that are very well connected (either in the finance industry, or old money, or close to politics). Similarly, there might be legal access restrictions - you must be a qualified investor, or reside in a certain jurisdiction, etc. etc.
Personally, I think most of the asset management industry is basically a giant rent seeking exercise, charging extraordinary fees (over the long run) for very little value. There are exceptional performers, but they are not accessible to most people. (As a side note, much of their exceptional performance might come from insider information more than exceptional analysis.)
Thus, the standard advice stands: put most in cheap index funds/ETFs, and maybe develop some expertise in certain areas and dabble in it with a fraction of your assets, if you're so inclined.
The reasons that the finance industry is particularly prone to unproductive money skimming (rent seeking) include:
* massive information asymmetry (similar to real estate)
* psychological biases (most people don't realise that someone taking a tiny 2% fee per annum has basically taken half your savings by the time you retire)
* mostly experience goods (or even post-experience goods): enormous difficulty of evaluating quality ex ante, or sometimes even ex post (your pension pays you X per month. Could a competitor have done better?)
* regulatory capture
etc.
The coin analogy is a perfectly legitimate parable to highlight how difficult it is to evaluate asset manager performance. Sure, the actual analysis then still needs to be done, but the outcome, from what I can tell, remains pretty damning.
The answer to question one, as you say, is yes. If it was purely coin tossing any group of performers would get halved each year (let's not mention skew). Now there are funds that fall quite hard, like Odey. But it's clear there are funds that seem to defy gravity.
Question Two. Here's how I decide if I believe in a fund.
Here's a real life example. A friend of a friend came to a meeting and explained that under certain circumstances, you can buy certain unit trusts cheaper than they're worth. You need to dig out the nitty gritty details of each fund: the holdings, the rules, the fees, trading regulations, and so on. You put all this in a computer, which tells you when there's a mispricing. You need good relations with various counterparties, or you won't get the trade. And you can only do it up to a certain scale, because there's only so much mispricing. And it's sensitive to costs, so you need his particular cost agreements.
This also explains why you'd have to invest in this particular guy. He has the infrastructure and relationships already in place, so even if you knew his method, you couldn't do it yourself.
You're right about a lot of funds being smoke and mirrors though. I used to run one, and the investors never ask the right questions. Mostly they chase returns, but they don't even know how to tell the difference between one track record and another. It makes a huge difference how they're generated, yet most questions are simply trying to put you in a category, like produce in a supermarket.
Wow!!!!!
I've never heard an owner of a hedge fund refer their fund as "smoke and mirrors". I really hope for your sake that you just misspoke.
I'm sorry it didn't work out for you. I understand how hard the industry can be, if you ever think of trying again, don't let your past failures dissuade you.
I'm available to chat if you'd like:)
As for smoke and mirrors, naturally I mean other people's funds! Mine actually would have won the bet with Warren by a fair margin.
Come to think of it, I was a partner before that in a fund that wasn't so good, but had lots and lots of investors climbing over each other to invest.
> most questions are simply trying to put you in a category, like produce in a supermarket.
Yeah, and who can blame them? It's very hard unless you have an inside edge. And lamentably many funds cater to those investors, put out nice and shiny brochures, and get good amounts of money to manage.
When firms like RenTec exist and continue to empirically generate market-beating returns over 20-30 year timespans, the burden ceases to be on the critic of a claim to empirically disprove it, especially if it's not even falsifiable. Here, you are doing the same thing as the previous commenter, except you're not using the analogy.
You cannot open your argument with the premise that returns are purely stochastic if that's not self-evident - you need to prove that. But I have never seen a single individual attempt to quantify the analogy, not even in a forced way to make it support their thesis. It's taken for granted that superlative returns are purely chance, and the goalposts are constantly moved whenever someone brings up successful funds.
That doesn't sound so stupid.
Kind of a side point but I don't see how this can be true. Wikipedia says Renaissance had $65 billion AUM as of 2015. If we back-track this compounded at 71.8% annually, that means Renaissance must have had at most $1.2 million in 1994, which is implausibly low. And $1.2 million is a maximum, because that figure assumes Renaissance hasn't received any new capital since 1994.
Also, you're assuming everyone who's put money into the fund has never taken it out, which would throw off your math quite a bit.
I don't disagree that most hedge funds are poor investment vehicles, but that's the nature of active investing. If the majority of hedge/mutual funds underperform the market, and you choose to invest in a fund of funds (essentially an index of their net performance), it doesn't really take a $1M bet to see who is going to lose.
I don't think Buffett would take a bet he didn't feel extremely confident about winning, but Ted Seides was just foolish. The only rational reason I can see for taking the other side of the bet given its terms was to generate publicity for himself and his own fund at the expense of some reputation a decade down the line. If he profited from that, I guess it was worth it for him. I really can't imagine he seriously believed he'd win.
And most people will never fully understand that until it happens to them. Then you have this eye opening moment, and you understand.
Nothing lasts forever. Conditions change in every arena of competition, not just the market. If a professional basketball player is incredibly successful until their bodies literally begin to degrade, do we raise philosophical questions about the inherent attribution of their skill?
People don't seem to respond well to the quant fund examples, so how about this - how has Warren Buffett consistently beat the market through Berkshire Hathaway? If he ceased beating the market this year, would it because he has been lucky all these years? Would it be because the market conditions that supported his success have fundamentally changed? If so, why does that indicate his performance was due to chance?
People were asking this back during the dotcom boom, when he lagged the market by a huge percentage.
Gotta wonder how many Warrens were unlucky enough to have this happen early on in their careers.
I recall reading a stock book back in the 1980s that claimed that Buffet's legendary status at the time was entirely due to his purchase of Geico
I'd even let you change your list Jan. 1st of each year as long as we agree that any hedge fund found to be a fraud of some kind counts as a zero in your sum.
This is actually a pretty good bet for you given how poorly one would expect stocks to perform over the next 10 years
Well, yeah, that's the point, isn't it? I thought these funds can't.
The average hedge fund seems to eat all its excess returns in fees. But around a third of all hedge funds, mostly upstarts, die in the first few years [3].
By analogy, if you can understand that Kleiner and Google create excess returns while most VC funds do not, you can understand why a similar exponential dynamic is at play with hedge funds.
[1] http://www.investmentreview.com/files/2009/12/18-241.pdf
[2] http://m.pionline.com/article/20141222/PRINT/312229982/big-p...
[3] https://www.forbes.com/forbes/welcome/?toURL=https://www.for...
Hedge fund returns average the same as passive equity
Implies that you should never invest in a hedge fund, because it's possible that they have individual characteristics which mean that they're more or less likely to fail, which you could notice when you invest. eg. Management is obviously incompetent, no track record, incoherent strategy, track record based on being long in a rising market etc.
If you believe that's the case, then you might still get above average returns by doing your homework.
But I guess given that assumption, still only worth it if you have enough money that you're completely able to lose that it's worth you spending the time to try and work out which hedge fund you trust (easier than spending your working days trading yourself).
So if you're an educated hnwi, maybe. If the chain is like you => your employer => your pension fund => some advisor => hedge fund, I'd guess not.
I don't have any evidence for this it's just what I believe.
Pershing Square for example is an obvious choice on LSE and is an arbitrage play as it looks like it will join the FSTE 250 and have to be brought by index funds.