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On Hedge Funds

I don’t think hedge funds are an optimal way to manage assets.  Here are some of my reasons:

  • The fees are too high.  Why pay 2% of assets, and give up 20% of the profits?
  • Hedge funds, aside from Commodity Trading Advisers and Global Macro funds, tend to be correlated, yield-seeking, and volatility-averse.  Why pay up for correlated performance?
  • The statistics behind hedge fund marketing suffer from backfill bias, survivor bias, and a few other biases.

Actual returns from hedge funds trail buy-and-hold returns by a significant margin.  Investors in hedge funds are poor timers of investment.  Though past results do not indicate future returns, investors act like that.  No one will add money to a losing fund, even if that is the point where it might start to do better.

To me it seems that we are running into the limits of arbitrage.  Shorting is unnatural, and so are many derivatives.  How much do you have to pay up to get someone else to take the other side of the trade?

Only so much stock/bonds, etc., can be lent out and shorted with no additional cost.  Beyond that, shorts have to pay up, and that crimps their profits.

This is one big reason why I am happy to be a long-only value investor.  I only have to focus of businesses making money versus their current share price.  I don’t have to deal with the games surrounding shorting.  That simplifies my decision making considerably.






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4 Responses to On Hedge Funds

  1. [...] funds are not very good. Their fees are too high, their returns are correlated, and their marketing statistics are suspect, [...]

  2. effem says:

    I agree on hedge funds (in aggregate, but you have to admit some have put up extraordinary returns that statistically cannot be luck).

    But isn’t private equity far, far worse?
    -Extremely high correlation + leverage
    -High fees + deal fees on top
    -Long lock ups
    -Returns that fall short of the market (when adjusted for the leverage they use)

    It baffles me how that industry got so big. I honestly think the biggest driver has been returns that APPEAR uncorrelated b/c the assets are illiquid and marked infrequently. The people running the pensions/endowments of this country don’t seem to be able to see through that illusion.

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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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