The Smart Money

[Gregmal]

https://nypost.com/2019/12/31/steve-cohen-one-of-few-bright-spots-in-bad-year-for-hedge-funds/

 

"The average hedge fund this year is up 8.5 percent"

 

How is this even possible? Just bouncing back moderately from last November/December should have had folks in low-mid teen return area. Would have thought for sure the returns would have been similar to what a lot of folks are posting in the 2019 returns thread.

 

Truly incredible the degree to which "the pros" just completely fail.

[Guest cherzeca]

(too) smart (by half) money.

 

 

[thepupil]

Would have thought for sure the returns would have been similar to what a lot of folks are posting in the 2019 returns thread.

 

Why would you think that? They take less market exposure and alpha for a diversified index of hedge funds is and has been trending toward zero to negative for about twenty years, plus there are fees.

 

To expect hedge funds to keep up with a 100% net long market that's up 30% would be to roll back about 2 decades of industry decline in alpha generation.

 

Gross Returns = Beta * Net Exposure +/- alpha

Net Returns = Gross Returns - Fees

 

The people in the thread are for the most part running 80-100%+ net long, so return from beta = 30% for the US folks and mid 20's on a global basis; the people in the thread don't charge themselves fees.

 

The hedge fund universe might run 30% net exposure in aggregate. I have no idea whther this number is 10% or 30% or 50%, but I assure you it's not 100% (most hedge funds hedge). So let's just assume 30%. Then the hedge fund universe in a year like 2019 should make about 10% from beta +- zero alpha in aggregate, minus some fees. I believe the 8.5% number includes all manner of hedge funds: long/short, global macro, fixed income arb, event driven, etc. so we may even be overestimating their equity exposure.

 

8.5% seems about right given what the market did.

 

imagine if you invested in every actively managed mutual fund, doubled the fee burden and shorted out 70% of the market exposure. You'd do pretty terribly. hede fund indices should pretty much never put up high absolute returns in a given year.

 

EDIT:

here's some data for ya

https://www.hedgefundresearch.com/family-indices/hfri-500-hedge-fund-indices#

 

[Gregmal]

Because these same "hedged" funds, also get walloped and underperform big time on the way down, as was evident last year and in previous choppy years as well.

 

Over the years, many "hedge" funds have evolved into largely long only or active in esoteric trading strategies, but certainly not hedged. If anything, as you insinuated, the "hedge" has just been salesmanned up to rationalize poor performance. You can justify doing 8% against 30% for the index when you did 10% vs -5% for the index the previous year, or something to that effect. It doesnt fly when you've underperformed the index by a huge margin for a decade.

 

Further, in relation to 2019, it is also surprising given how, basically starting in q2, there was a noticeable capitulation amongst many of the smart money funds; the FANG stuff literally started showing up everywhere in the August and November filings. So somehow, even with the outperformers, these geniuses found a way to suck wind again. This, plus, assuming you didn't totally get played last December, everyone, period, no matter what "strategy" you used, got a 10% bump just holding onto the same stuff they owned for the first couple weeks of January.

[Guest cherzeca]

seems to me most hedge funds make bull/bear bets on mostly individual names, go short or long on individual stock analysis, rather than a market-neutral arbitrage basis such as ed thorp did.  some macro funds certainly take more longitudinal bets based on macro views, and certainly many hedge funds have a macro bias which may incentivize more short or long positions than normal.

 

so yes on a strong long year, I can see hedge funds doing less well than the S&P500, but over 20% negative alpha?  just too much cocktail party/country club silo thinking if you ask me...

[thepupil]

Here's the annual return of the HFRI Fund Weighted Composite Index versus the S&P 500 with an "estimated alpha" assuming the HFRI runs on average 30% net (so if market =10% and the HFRI does 3%, that's 0% alpha, no value add relative to market exposure).

 

Again this is just a simplified spitball analysis.

 

My point is that this is not news. Alpha has been near zero since 2012.

 

Hedge Funds have not outperformed a strong up market on an absolute basis since 1999 when they made 31% to the S&P's 21%.

 

 

 

[Guest cherzeca]

@pupil

 

I disagree with your set up.  I dont give HFs a pass to account for their having a net long exposure less than 100%.  whether you are long, short or a mix, your portfolio as constructed should represent your best estimate of risk/return, so choose your appropriate benchmark and compare straight up to that benchmark; so I would compare the 2019 HF 8.5% return straight up against the 29% S&P500 return. 

[muscleman]

https://nypost.com/2019/12/31/steve-cohen-one-of-few-bright-spots-in-bad-year-for-hedge-funds/

 

"The average hedge fund this year is up 8.5 percent"

 

How is this even possible? Just bouncing back moderately from last November/December should have had folks in low-mid teen return area. Would have thought for sure the returns would have been similar to what a lot of folks are posting in the 2019 returns thread.

 

Truly incredible the degree to which "the pros" just completely fail.

 

You are assuming that they are 100% long all the time, which is not the case with hedge funds.

When the index went down 20% last year, they were probably down 8%.

[Gregmal]

Or put another way, the "we dont try to beat the index" only became a marketing pitch after years of futility. If the mostly widely accessible, highly endorsed, liquid product, available to absolutely anyone, did 30%, and you did less, YOU made the wrong call. Now I say that lightly, because strategies change and no one gets it right all the time. In fact, I dont even think every fund manager, should consistently be expected to beat an index all the time, but performance like what many of these guys put up is inexcusable. And to make matters worse, they cant ever say "we were wrong". So instead they dishonestly move the goalposts around and pay healthy sums of your fee extracted money to marketing folks to come up with clever new spin and sales speak. I know plenty of folks who manage money and who dont always "beat the index". I know plenty of folks, who do. None of them "need" all these super fancy offices, and suites, watch, shoe ensembles to do their jobs. They dont need the fancy degrees from waspy universities either. In fact, I think the story of Bill Ackman is a pretty informative one to observe. He got caught up in his fame, his arrogance and ego became his undoing, his celebrity status and wealth became the product, and he sucked a big one. He then commits to get back to basics, downsized his firm, kept quiet, basically became simplified and long only...and voila, his returns this past year basically resembled those of many of the fine folks here who do those returns from home/normal people offices, AND CRUSHED "the market".

 

I think a lot of the "highly complex" stuff is also just marketing bullshit. There s a line in the Big Short, something to the extent of "its meant to be that way to make everyone feel stupid"...and I think a lot of that applies with these funds. There are obvious exceptions...despite blowing up, the LTCM guys for instance probably warrant their weight in gold, as do others. But the majority are judge ultra advanced hucksters.

[Gregmal]

https://nypost.com/2019/12/31/steve-cohen-one-of-few-bright-spots-in-bad-year-for-hedge-funds/

 

"The average hedge fund this year is up 8.5 percent"

 

How is this even possible? Just bouncing back moderately from last November/December should have had folks in low-mid teen return area. Would have thought for sure the returns would have been similar to what a lot of folks are posting in the 2019 returns thread.

 

Truly incredible the degree to which "the pros" just completely fail.

 

You are assuming that they are 100% long all the time, which is not the case with hedge funds.

When the index went down 20% last year, they were probably down 8%.

 

The index fell 5% last year, and the smart folks "only" lost 4%. Thats a big 90 basis points of outperformance during a bad year if it means sacrificing 20%+ during a good one.

 

Overall, the industry saw its biggest annual loss since 2011, declining 4.1 percent on an a fund-weighted basis, according to Hedge Fund Research Inc.

 

https://www.bloomberg.com/news/articles/2019-01-09/hedge-fund-performance-in-2018-the-good-the-bad-and-the-ugly

[muscleman]

https://nypost.com/2019/12/31/steve-cohen-one-of-few-bright-spots-in-bad-year-for-hedge-funds/

 

"The average hedge fund this year is up 8.5 percent"

 

How is this even possible? Just bouncing back moderately from last November/December should have had folks in low-mid teen return area. Would have thought for sure the returns would have been similar to what a lot of folks are posting in the 2019 returns thread.

 

Truly incredible the degree to which "the pros" just completely fail.

 

You are assuming that they are 100% long all the time, which is not the case with hedge funds.

When the index went down 20% last year, they were probably down 8%.

 

The index fell 5% last year, and the smart folks "only" lost 4%. Thats a big 90 basis points of outperformance during a bad year if it means sacrificing 20%+ during a good one.

 

Overall, the industry saw its biggest annual loss since 2011, declining 4.1 percent on an a fund-weighted basis, according to Hedge Fund Research Inc.

 

https://www.bloomberg.com/news/articles/2019-01-09/hedge-fund-performance-in-2018-the-good-the-bad-and-the-ugly

 

I am more interested in how David Tepper and Ren tech did last year than how the overall hedge fund industry did. Just because someone is doing it full time doesn't mean they are better.

[thepupil]

Or put another way, the "we dont try to beat the index" only became a marketing pitch after years of futility.

 

I don't agree. I have a copy of Pioneering Portfolio Management here, published in 2000, in the heyday of hedge fund alpha and before the huge growth in assets and number of funds that preceded the ultimate decline of industry alpha.

 

After adjusting for fees and incentive compensation, investors employing a combination of event-driven and value-driven strategies might reasonably expect nominal returns of 10-12% more or less equivalent to the long term return to domestic equities with lower risk and essentially no correlation...well managed absolute return portfolios provide a high return, low-risk source of diversifying returns

 

this quote is in the context of a seemingly normal 4% cash rate, so cash +6-8%

 

The dream sold to institutional investors to invest in hedge funds was never "beat the market". It was "keep up with the market, make more than bonds with little duration risk, and make a significant premium to the cash rate"; get a diversifying return stream (not the duration of bonds or beta of stocks) without sacrificing too much return.

 

I say a dream, because alpha/premium to cash/bonds has declined significantly because too many people read Pioneering Portfolio Management in 2000 and wanted to be like Yale.

 

I share everyone's negative view of the industry as a whole, but I think it's important to understand what most of them are trying to actually do. Few hedge funds try to beat the stock market in a given short term time frame. all try to add value realtive to whatever they consider their sandbox. in aggregate value add is probably close to 0 before fees and negative thereafter.

 

 

[Guest cherzeca]

@pupil

 

ok we disagree, but I have spoken to various HFers, and it seems clear to me that they want to maximize the multiplicand against which their 20% is applied.

[thepupil]

@pupil

 

ok we disagree, but I have spoken to various HFers, and it seems clear to me that they want to maximize the multiplicand against which their 20% is applied.

 

Well I certainly won't argue with that!

 

I'm arguing with the idea that anyone that invest in scale in hedge funds really expects to outperform the market. The goals of institutional investors investing in hedge funds is not to beat the market. Here's some more modern stuff from the folks at Yale. They outright say that they have a slightly lower return expectation for "absolute return strategies" than equities.

 

And I'd say their estimate for absolute return strategis of 4.8% real is high and builds in a lot of "manager selection alpha" (perhaps justified by their long term record).

 

https://static1.squarespace.com/static/55db7b87e4b0dca22fba2438/t/5c8b09008165f55d4bec1a36/1552615684090/2018+Yale+Endowment.pdf

 

In July 1990, Yale became the first institutional investor to define absolute return strategies as a distinct asset class, beginning with a target allocation of 15.0%. Designed to provide significant diversification to the Endowment, absolute return investments are expected to generate high long-term real returns by exploiting market inefficiencies. The portfolio is invested in two broad categories: event-driven strategies and value-driven strategies. Event-driven strategies rely on a specific corporate event, such as a merger, spin-off, or bankruptcy restructuring, to achieve a target price. Value-driven strategies involve hedged positions in assets or securities with prices that diverge from their underlying economic value. Today, the absolute return portfolio is targeted to be 26.0% of the Endowment, above the average educational institution’s allocation of 21.7% to such strategies. Absolute return strategies are expected to generate a real return of 4.8% with risk of 8.6%. The Barclays 9 to 12 Month Treasury Index serves as the portfolio benchmark. Unlike traditional marketable securities, absolute return investments have historically provided returns largely independent of overall market moves. Over the past twenty years, the portfolio exceeded expectations, returning 8.3% per year with low correlation to domestic stock and bond markets.

 

Equity owners reasonably expect to receive returns superior to those produced by less risky assets such as bonds and cash. The predominant asset class in most U.S. institutional portfolios, domestic equity represents a large, liquid, and heavily researched market. While the average educational institution invests 20.4% of assets in domestic equities, Yale’s target allocation to this asset class is only 3.0%. The domestic equity portfolio has an expected real return of 6.0% with a standard deviation of 18.0%. The Wilshire 5000 Index serves as the portfolio benchmark. Despite recognizing that the U.S. equity market is highly efficient, Yale elects to pursue active management strategies, aspiring to outperform the market index by a few percentage points, net of fees, annually. Because superior stock selection provides the most consistent and reliable opportunity for generating attractive returns, the University favors managers with exceptional bottom-up, fundamental research capabilities. Managers searching for out-of-favor securities often find stocks that are cheap in relation to fundamental measures such as asset value, future earnings, or cash flow. Yale’s domestic equity portfolio has posted returns of 11.8% per year over the past twenty years.

 

 

 

[Guest cherzeca]

@pupil

 

so I understand your point of view now, but it seems to me that it is an institutional investor's point of view (ie Yale, an excellent investor) rather than a hedge fund's point of view.  of course, some HFs will adopt a strategy that is designed to be benchmarked against something quite different than the S&P500, and of course it is appropriate to measure that performance against the relevant benchmark.  all I am saying is that many equities HFs would readily adopt the S&P500 as the appropriate benchmark, and jiggering their return with the excuse that they were part short is just BS, since the impetus to be part short is derived from an impetus to outperform the S&P500 benchmark (because the HFer is so smart that it can correctly identify both undervalued and overvalued stocks, and not to achieve a somewhat lower portfolio volatility/risk).  just imo

[thowed]

I think everybody's made some interesting points here, but I'd go back to basics and say that it is completely pointless to make any comment about 'hedge funds' as it can mean too many different things.

 

If you are a long-biased hedge fund, then Gregmal's point are entirely valid.

 

But the problem with these articles is that the definition of 'hedge funds' includes long funds with various Macro funds, bond funds, commodity funds, Arb, Short only funds etc. etc. And so this makes the 8.5% figure meaningless.

 

Except that if you're a journalist you need the figure to be either much lower or higher than the S&P500 so that you have an angle for your feature.