4 ms·

That's not the full picture, really. 1) Since a large chunk of the money on financial markets flows between funds, and this is pretty much a zero sum game, the

by andr 18y ago

That's not the full picture, really. 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.

nostrademons 18y ago
That's some pretty funny accounting. 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.
- andr 18y ago
  Ah, but you missed the "other things being equal" part. ;) If the markets move as a whole and hedge funds are heavily long on the market, but others are market-neutral, or even short, things are not equal.
  - nostrademons 18y ago
    Right, but on the whole, you'd expect those all to average out. If the markets move up and hedge funds are long, they're as likely to move down while hedge funds are long, or move up while hedge funds are short.
    - andr 18y ago
      That is why better hedge funds know when to be long and when to be short. My explanation makes a lot of assumptions for simplification, because it is impossible to know what every hedge fund is doing at every point in time.
deleted 18y ago
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nandemo 18y ago
No, 2.4% is just a relative return. In your example, the absolute return is -17.6% so the hedge fund managers won't gain anything beyond the 2% or so administration fee. 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.

by andr 18y ago

nostrademons 18y ago

That's some pretty funny accounting. 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.

andr 18y ago
Ah, but you missed the "other things being equal" part. ;) If the markets move as a whole and hedge funds are heavily long on the market, but others are market-neutral, or even short, things are not equal.
- nostrademons 18y ago
  Right, but on the whole, you'd expect those all to average out. If the markets move up and hedge funds are long, they're as likely to move down while hedge funds are long, or move up while hedge funds are short.
  - andr 18y ago
    That is why better hedge funds know when to be long and when to be short. My explanation makes a lot of assumptions for simplification, because it is impossible to know what every hedge fund is doing at every point in time.

deleted 18y ago

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nandemo 18y ago

No, 2.4% is just a relative return. In your example, the absolute return is -17.6% so the hedge fund managers won't gain anything beyond the 2% or so administration fee. 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.