Hedge funds turn out not to work: average fund down 17.6% for the year
nytimes.com
nytimes.com
"This unregulated, at times volatile corner of finance which is supposed to make money in bull and bear markets lost $180 billion during the last three months."
Our financial systems are heavily regulated. The specific regulations that the author would like to see may not exist, but this does not justify claiming that hedge funds are unregulated. Many people seem to believe that all risk should be regulated away and actually believe that this is possible. More information on current regulations that hedge funds are subject to:
http://www.forbes.com/opinions/2007/04/13/hedge-fund-regulat...
"Many hedge fund investors, particularly the wealthy individuals, are flabbergasted by their losses this year. The average fund was down 17.6 percent through Tuesday, according to Hedge Fund Research."
The S&P 500 is down 40% for the year.
(And then you can curse me when we get hyperinflation, the stock market shoots up, and all that cash becomes useless.)
Or were you just lucky to have assets in cash at the right time?
When I was first starting my startup, I figured I ought to rebalance my portfolio just so I could forget about it while I worked. Tallied everything up, divided them up by asset classes, and figured out what dollar value I wanted in each fund. And I moved some of it around, into bonds and out of individual stocks and such.
But when it came to putting money into an S&P 500 index fund, I just couldn't do it. I had the Vanguard website open, everything ready to invest, form filled out, but my gut told me that there was no possible way that the stock market was worth what the ticker said it was worth. I'd previously worked at a financial software startup, so I had all the stats on market P/E, record earnings, leverage levels, etc. So I closed the window and forgot about it.
This was on Oct 5. The S&P 500 peaked on Oct 11.
So yeah, a whole lot of luck, and maybe a little knowledge thrown in. I tell this story because everyone here's coming up with excuses for hedge funds: they're "only" down 17.6% when the market is down 40%, or they got those outlandish returns with less risk, or they're really really smart and so should be compensated for those sophisticated quant models. But excuses don't matter in finance - only your return. Ultimately, it's a whole lot of luck and a little knowledge - for everybody. I predict we'll see many, many more hedge funds do a lot worse in the coming year.
Especially passive management investments?
I'm waiting to put money in because I don't yet have a job, and so may need that cash to fund another startup (there's that luck aspect again; had I not been starting a startup last year, I likely would've had way more in the market). But if I had a normal employment situation, I'd be gradually money into stocks, towards a more normal asset allocation.
As for a retirement 20 years out - I wouldn't even try to predict that. I haven't touched my Roth IRA this crisis, nor do I count it in overall returns (haven't even looked, really). The one thing I would say is to have some international exposure. Prices rise or fall based on how reality compares to the market's expectations, and I think it's unlikely that America in 20+ years will have the hegemonic position it does now.
Another important point is that many hedge funds are, or at least claim to be, equity-market neutral. They do it by short selling and by investing in other asset classes. So the fact that S&P is down 40% is a perfectly good excuse for a index fund manager, and a fairly good excuse for an active mutual fund manager, but not a very good excuse for a hedge fund. In fact you can see some hedge funds apologizing for the bad performance: http://dealbreaker.com/images/thumbs/TPG%20Axon%20Investor%2...
1) Since a large chunk of the money on financial markets flows between funds, and this is pretty much a zero sum game, the average hedge fund performance is bound to be around 0%, other things being equal. It's your fault if you pick the wrong hedge fund, or you don't know the risks.
2) A lot of hedge funds do not target an absolute return, but rather a return on top of the market's return (and they pick an index or several which they consider to be "the market"). So if the market is down 20%, but funds are down 17.6% on average, then they have actually made a 2.4% average return compared to the index they follow. As weird as this may sound, this is actually a success for them. They would usually get a cut of the 2.4% gains as their commission.
One of the main reasons is that absolute return funds are mostly quantitative and/or derivatives-based, and those are much harder to do than buying stocks by your gut feeling (which is what a large number of funds do, really). The other reason is that when a fund is big ($5bn+) it is very hard to move your positions around quickly (as would be required for an absolute return strategy), without shaking the market, and losing money in the process.
By your first point, hedge funds are the market, and so between all of them, ought to average exactly the market returns. By your second point, they measure their returns against the market, and so on average should return 0%.
Why should anyone ever invest in hedge funds, under these premises?
A much simpler (and probably truer) explanation is "What goes up, must come down." Hedge funds booked large paper profits during the boom; now it's time for them to book large paper losses in the bust. Except that if their customers get scared, those large paper losses turn into large actual losses.
This is not a success for them or for their clients (and that is the point of HN post title!). Arguably the defining feature of hedge funds is the expectation (or claim) of positive returns independently of market conditions. In other words, they usually do target absolute returns. Otherwise there would be little basis for charging 2% of assets plus 20% of profits.
By the way, the zero sum game thing or, equivalently, average return of 0%, only makes sense if: a) compared to the average market return AND b) you consider all the "players", not only hedge funds.
A lot of critics blame everything on deregulation. But the big banks were the most regulated part of the financial system, and they have imploded. Meanwhile hedge funds have the least regulation, and while they haven't been making money, they at least are not threatening to destroy our financial system.
The Economist had a much better article on hedge funds in the aftermath of the financial crisis.
http://www.economist.com/finance/displaystory.cfm?story_id=1...
Particularly, hedge funds have not been allowed to hedge! If the government bans short-selling in the hardest-hit stocks, don't be surprised if a hedging strategy doesn't work any more.
I think this is not true.
It is my understanding that it was the big, less regulated investment houses that got into a lot of trouble with mortgage securities. The heavily regulated retail/commercial banks haven't suffered nearly as much.
Unless we are defining "banks" differently...?
Hedge funds don't just invest in stocks. They can bet on anything, including stocks going down. This is supposed to allow them to make money in down markets as well.
Hedge funds are like startups, really. All of them do the same thing on paper, but some do it better, so it's your responsibility (and a bit of luck, of course) to pick the good ones.
However, hedge funds typically use a lot of leverage to make their returns, even as high as 20x. Given the credit contraction, I can see how this can kill their returns. I don't understand why someone would lend a hedge fund this money.
On a related note, I saw that K-mart advertised their "layaway" program for xmas. I hadn't heard that since I was a kid.
http://www.marketwatch.com/quotes/gc08z?sid=1633395
I agree that hedge funds can invest in anything (unlike MFs, which are regulated) but if you look at the short term (4-week) T-bills their interest rates are down by as much as 62% since 2002, so the general consensus is that, that is where most money is getting drained.
Why? They are the most conservative, safe investment choices available. If I may digress, this is not a good thing for the economy as we are not using that money to produce anything.
Considering the Dow is down over 30% and counting for the year, 17.6% down seems impressive to me :-)
Oops, sorry, was relying on a news story I saw a couple weeks ago. It was doing better than the stock market a couple weeks ago, though, which was what I was getting at.
[Citation needed].
Everything I can find indicates that the price of gold is about the same as a year ago, while platinum has severely dropped due to lower demand from the car industry.
Hedgefunds are designed to outperform benchmark indices. Outperforming by 23% is phenomenal.
By the logic of the poster, a year where the SP500 returned 50% and a fund returned 10% would be proof that hedge funds DO work. That fund manager would be immediately fired.
Hedge funds have outperformed for the last 10 years. Taking a one year performance that loses money doesn't mean anything.
The other reason is highly leveraged funds when the margin requirements went up after interest rates raise.
All this means that hedge funds have been unable to ride to the rescue of global markets. According to the IMF, the average cash balance of hedge funds has risen from 14% last year to 22%, while the amount of leverage (borrowed money) they use has fallen from 70% of capital to 40%. In theory, that gives them the firepower to buy now that prices have fallen; in practice, they may need their cash to repay clients that want to redeem their holdings.
You are only as smart as your dumbest investor is.
This is tantamount to claiming that poker doesn't "work" because the "average" player breaks even.
This, I assume, is a bit of a joke since hedge funds have largely turned into speculation funds which take risky positions in the hopes of large returns.
Hedging doesn't mean you always make money. It means that if your main instrument falls, instrument B is going to go up and cover some of the losses, but not all of them.
From http://en.wikipedia.org/wiki/Hedge_fund#History:
Sociologist, author, and financial journalist Alfred W. Jones is credited with the creation of the first hedge fund in 1949.[2] Jones believed that price movements of an individual asset could be seen as having a component due to the overall market and a component due to the performance of the asset itself. In order to neutralise the effect of overall market movement he balanced his portfolio by buying assets whose price he expected to rise and selling short assets he expected to fall. He saw that price movements due to the overall market would be cancelled out because if the overall market rose the loss on shorted assets would be cancelled by the additional gain on assets bought and vice-versa. Because the effect is to 'hedge' that part of the risk due to overall market movements this became known as a hedge fund.
The S&P is down ~38% year-to-date; would it also follow that stocks, stock markets, or shareholder capitalism "turn out not to work"?
Wouldn't anyone in an S&P index fund rather be in one of these awful, awful "average" hedge funds? I know I would -- even just for 2008, never mind the many up years!
Okay, so a US treasury bond is equivalent to a UK treasury bond, except it's off by 0.0005%. So you buy billions/trillions of each and the price converges, and you make millions.