Simon Lack, CFA, is founder of SL Advisors, LLC. Previously, he worked in North American fixed-income derivatives and forward foreign exchange trading for JPMorgan. Mr. Lack also sat on JPMorgan’s investment committee and founded JPMorgan Incubator Funds, two private equity vehicles that took economic stakes in emerging hedge fund managers. Currently, he chairs both the Investment Committee for Wardlaw-Hartridge School in Edison, NJ, and the Memorial Endowment Trust Investment Committee of St. Paul’s Episcopal Church in Westfield, NJ. Mr. Lack is the author of The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True and Bonds Are Not Forever: The Crisis Facing Fixed Income Investors. You may access the book summary for The Hedge Fund Miragevia getAbstract.
Key issues include the following.
- How well have hedge fund investors really performed and why?
- How should investors use hedge funds?
- Why aren’t investors negotiating more favorable terms?
My session notes follow. As always, these are contemporaneous notes. I make no guaranty as to their accuracy or completeness.
- “If all the money that’s ever been invested in hedge funds had been put in treasury bills instead, the results would have been twice as good.”
- The vast majority of books about the hedge fund industry are uncritically fawning. Exceptions include When Genius Failed and Hedge Hogging.
- Annual hedge fund returns (1998-2013) are roughly 6%. But asset-weighted returns show a much different story. As size increases, good strategies are copied and the advantage is dissipated. When a small industry, hedge funds performed rather well, especially on a risk-adjusted basis. As assets moved their way, performance declined (as usual). The “trade” became too crowded.
- “Being a hedge fund manager has always been more profitable than being a hedge fund client.”
- Problems: fees (obviously too high); lack of transparency (improving slightly); size (the first person to the buffet table gets the best stuff); lack of investor protections.
- Survivorship bias?
- Slicing the pie (in the aggregate): hedge fund fees are well more than 80% of profits made: FoF fees are about 15%; real investor profits are barely 1-2%.
- Transparency matters: e.g., bid/ask spread and valuation issues (mid-market or bid side?) magnified with leverage; costs aren’t equally shared (early investors pay for later ones due to transaction costs when new money is put to work).
- Hedge funds are over-capitalized – hedge funds rarely recognize the restrictions that size puts on returns.
- Success requires investment success and running a successful business.
- They will always be at least a few great hedge fund managers. But is buying one ever a smart bet?
- Most laughable hedge fund pitch? “I’ll get good results and money will just show up.”
- Strategic decisions are amenable to group decision-making, but tactical decisions are not.
- Fees are too high; hedge funds such run separately managed accounts.
- Hedge fund managers tend to be conservative and risk-averse. They don’t tend to blow-up or even lose 20% and shut down. Instead, they simply underperform and bleed out.
- “Investing should never be in a hurry.”
- Looking for the top 40% of managers – only 7% stayed there. Seriously mean-reverting vehicles. But nobody wants to invest in out-of-favor hedge funds.
- Is it ever a good idea to buy into a hedge fund? You need idiosyncratic returns to succeed. Thus manager selection is key and hedge fund diversification pushes overall performance toward the mean.
- The decrease in big bank prop trading should be positive for hedge funds, but not nearly enough.
- What happens from here? Returns continue to disappoint and $AUM continues to grow. You’ll be happy so long as your expectations are low.