Comment by scrumper | Hacker News Reader

Comment by scrumper | Hacker News Reader

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I'm always happy to read good articles about hedge funds so I'd hate for this comment to come across as a dismissal - it's not. That being said, the uninitiated should be a bit wary of this line, which is a good example of a class of hedge fund commentary that appears a lot:

hedge funds have consistently underperformed the market in recent years: last year the average hedge fund made 3.3%; S&P 500 index gained 11.4%.

We're in the late stages of a bull market in equities. Hedge funds are traditionally set up to protect assets or even generate returns in downturns; one of the things you trade away for that safety is full participation in market gains. So I'd expect a canonical, 'good' hedge fund to underperform a bit in an upswing but be flat or potentially even positive in a down market.

The article talks a bit in the second half about how hedge funds achieve this - where the 'hedge' comes from - so the insight is there if you think hard about it: you have to pay for the hedge somehow, and it comes out of your upside participation.

The reason hedge funds are falling out of favor is more to do with a surfeit of crappy funds, which again the article hints at but is too polite to explain. A lot of that collective underperformance post 2008 is down to a huge population of 'me too' equity long/short funds all following rote strategies. That statistic conceals the limited number of cleverly managed, fast moving funds which were able to take contrary positions in the credit bubble and protect their investor's money by shorting CDSs.

All of which is to say, the industry needs a shakeup and maybe this variable fee structure has a role to play. Good luck to them.

> The reason hedge funds are falling out of favor is more to do with a surfeit of crappy funds ... > That statistic conceals the limited number of cleverly managed, fast moving funds which were able to take contrary positions in the credit bubble and protect their investor's money by shorting CDSs.

Suppose as a matter of self reflection, I determine that I don't have whatever intrinsic ability + learned skill + ??? is needed to pick securities such that will consistently outperform passive investing strategies. Does that necessarily imply that I don't have the ability to pick an active fund from among the available funds that will outperform (given a certain goal)? Or is it a different skill set?

Note I'm not asking you to tell me how to go about doing that, I can get ten answers from ten different people. What am asking is there conceptually a talent/skill that would allow me to do that, and should I have any reason to think I've got it?

What am asking is there conceptually a talent/skill that would allow me to do that, and should I have any reason to think I've got it?

Excellent question. The answer, well my answer, is that it's a different skill set. I think the value the manager brings is their skill and diligence in handling the implementation details (which commodities to buy, securities to short, options to write; how to manage risk) of a strategy, which could be as simple as some directional conviction (I like renewables, say) or a philosophy (opportunistic investing in special situations in mid caps).

Your skill is that of an educated consumer: deciding what product you want (your conviction), and selecting a provider based on whatever subjective and objective metrics you deem important. Not all that dissimilar from choosing any expert vendor in an area you don't understand in depth - doctors, contractors, lawyers, even financial advisors (to whom you could outsource the selection part entirely, of course)

Note that nowhere here am I denying the existence of luck in getting into those funds which were able to do well in the crisis.

Re: hiring expert vendors

In my experience most people are terrible at that. Even if you go online and look at what other people have to say, those people have no idea about how well the professional did, given that they didn't know expected distribution of outcomes should have been to begin with. Clients often end up being unreasonably thrilled with a mildly positive result in an easy case and unreasonably pissed off with a mildly positive result in a really tough case.

The whole thing ends up devolving into a personality, and sometimes literal, beauty contest.

True. I'm actually amazed that many business owners are able to select and get good outcomes from expert vendors, when they have a very limited understanding of how those vendors achieve their results.

Perhaps this is the reason for the prevalent advice that consultants should sell the benefits/outcomes, get referrals, rather than focus on the technical tasks they will undertake to achieve the outcomes. The business owner to whom they are selling has no means to evaluate claims of their technical chops. But, if they see the consultant has succeeded in something similar for 10 previous clients, then that may be enough for them to make a decision to start.

That's true, though I'd have to hope those people in the market for alternative investments would, if only by virtue of more frequent exposure to professional advisors, have a more sophisticated approach.

Perhaps that's where funds of funds come in. FoF managers can spend all day evaluating various hedge funds' performance/execution/whatever. But how do you pick a FoF manager?

Heh heh heh this is exactly the right question. A fund is just another tradable instrument. I don't see much difference between evaluating the fund's management and historical performance vs. evaluating those of a public corporation -- except that in the latter case, you can probably get more information.

I saw an analysis somewhere that claimed that for mutual funds, annual performance is negatively autocorrelated: the funds that are likeliest to do well next year are the ones that did the worst last year. I wouldn't be surprised if this held true for hedge funds as well.

Except that, in terms of investment exposure, your effort is leveraged significantly when you evaluate a fund's management vs. a single public company.

Thanks for your thoughtful comment. Agreed that there are some bad apples in the HF space and I think that many of them will die in the next few years. Unfortunately, many emerging managers can't start their own hedge fund because it takes a minimum of $250 million just to get the ball rolling. At Instavest, we hope to be a launching platform for these folks while delivering value to other investors.

I kind of thought that would be your play - I just replied to another comment below; I wonder how close to the mark I am.

I'll be watching closely.

By definition, the canonical hedge fund should be uncorrelated with the market.

You are right. Weak use of 'canonical' on my part; irony not lost. The sense I was going for was 'idealized, within bounds of real world practicality.'

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