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84% of the investment gains from hedge fund went to the managers
- sakai 15y agoIt's worth pointing out that the FT's 84% figure is NOT correct, though that actually further reinforces the point that fund managers are fleecing their investors. While the funds collectively realized $449bn in investment gains and paid out $379bn in fees to managers, the hedge funds earned a significant portion of these fees without making their clients a penny. Rather a fraction of the $379bn is a share of the gains fund managers made their clients, while the (likely very large) remainder of the $449 is derived from straight management fees (typically 2% of invested assets).
- OstiaAntica 15y agoEven worse, hedge fund managers somehow get their income classified as "capital gains" and only pay the 15% rate on their earned income, even though they never had any cash equity at risk. It is a massive subsidy to the industry and it is grossly unfair to other taxpaying Americans. I have similar sweat equity in my tech company, and have to pay income tax rates and payroll taxes on my earnings.
- patio11 15y agoConsider reinvesting a portion of the profits from your tech company and later selling equity at long-term capital gains rates. (n.b. This advice is isomorphic under any possible opinion regarding hedge funds if one's goal is to minimize taxes.)
- solutionyogi 15y agoBut who would you sell the equity to? Wouldn't it be really hard to find a buyer for equity in a private firm? Or am I missing something obvious here?
- JumpCrisscross 15y agoSecondMarket and Liquidnet operate private shares trading businesses
- guelo 15y agoAnd when there was some noise a couple years ago about changing that tax loophole the idea was immediately squashed by congress and it died a quiet death. Almost as if congress does Wall Street's bidding to the detriment of the overall national interest. Almost.
- tmh88j 15y agoThat "loophole" you're talking about is known as carried interest. Carried interest exists for a good reason (at least to my understanding); so that partners can with less capital can build sweat equity. Sure there are people who take advantage of it, but it does serve a purpose (taxes more so than retaining their profits). I'm not saying there aren't plenty of greedy hedge fund managers, but understanding why it exists will at least help form a solid opinion. >The arguments for the carried interest are fairly compelling: without it, the partners who contributed ideas and talent end up being taxed much more heavily on their earnings than partners who contributed financial assets. This is not only sort of unfair, and impedes the ability of talented people with few financial resources to move into the moneyed class, but also might have implications for economic growth: if your gains are going to be taxed at ordinary income rates, why quit that safe job and risk all on an untried venture? http://www.theatlantic.com/business/archive/2011/08/thinking-about-taxes/243651/ http://www.theatlantic.com/business/archive/2011/08/thinking...
- yummyfajitas 15y agoI have similar sweat equity in my tech company, and have to pay income tax rates and payroll taxes on my earnings. No, you have to pay income tax rates and payroll taxes on your salary. Sweat equity is taxed at capital gains rates, much like the sweat equity of hedge fund managers. (Except for the various special cases when it is not. I've only gotten equity at the stage of founding the company, I'm told it's taxed differently if you get it as part of your comp package when you work at google.)
- OstiaAntica 15y agoHere's how the hedge fund tax deal is different: http://en.wikipedia.org/wiki/Carried_interest http://en.wikipedia.org/wiki/Carried_interest
- DevX101 15y agoWarren Buffet made a bet that a market index (S&P500) would outperform hedge funds. So far, he seems to be winning the bet. http://longbets.org/362/ http://longbets.org/362/ As the hedge fund market grows by 10x, its all but certain returns will decline. The economy isn't a zero sum game but when investment funds grow faster than investment opportunities, logic dictates that median performance will fall and there will be more absolute losers. Furthermore, picking a hedge fund manager becomes an exercise in futility as the number of managers increase. The pension fund administrator can pick the 1 in 10 stocks he believes will return 15% per annum or he can pick the 1 in 20 hedge fund managers he believes will return 15% per annum. (The numbers here are made up but I hope you see my point). Either way, the pension fund administrator will need to research on where to park money, but I'd argue the variables to predict future performance are much more transparent with stocks than with hedge funds. All the administrator has done is transformed the problem of picking a winning stock, to picking a winning hedge fund. The only difference being the hedge fund is guaranteed to take a cut of your money.
- suking 15y agoThere are advisors and fund of funds just to hedge your bet on hedge funds - and like you said - it's only going to get harder. Picking a hedge fund is going to be like picking the next hot pharma company.
- deleted 15y ago[deleted]
- xefer 15y agoWell that's more or less what tese things are. Instead of investing in a startup, your effectively betting that a group of money managers will hit pay-dirt with a unique investment strategy. For te most part only people with so much money they can afford to risk a pile can even play
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- BenOfTomorrow 15y ago
- thrill 15y agoIt's interesting to me that the people who rant about hedge funds ignore that participation in them is entirely voluntary and even restricted to the wealthy few.
- DevX101 15y agoThe biggest source of hedge fund money are pensions. I'm quite certain the workers didn't volunteer to put their money into hedge funds.
- Tycho 15y agoAre you sure about that? Isn't that mutual funds?
- Tsagadai 15y agoCompletely sure. My Australian superannuation/pension was heavily tied up with various hedgefunds and it lost about 50% of its value in 2008. I can't tell them how to spend my money and I can only change between a very similar set of funds. Many pensions around the world are in similar arrangements with hedgefunds and investment banks.
- adamtmca 15y agoSomeone managing a pension fund is a sophisticated investor. My sister is a teacher with a claim on the sizeable Ontario teachers pension fund but she doesn't pick the individual investments they do, nor should she.
- JumpCrisscross 15y agoThere is a problem with this analysis - the 449 figure is capital paid out, not gains. The worst funds have their capital withdrawn at the fastest rates; investors in the best funds tend to keep their capital put. By Lack's metric, which ignores un-realised gains, Warren Buffett's Berkshire Hathaway, which hasn't paid a dividend but pays salaries to its "managers" is a ruddy failure of an investment institution. It should also be noted that not all cash taken by the fund manager as compensation goes straight into the mamagers' pockets - there are staff, Bloomberg terminals, and office space to be paid for. At smaller funds, the 2% asset fee can sometimes barely cover that. The FT author likens hedge fund statistics to a "statistical minefield". Rather helps if you don't lay the mine you blow up.
- sakai 15y agoThe article does call them gains, but if it's truly only the capital paid out this is a good point. More likely, these numbers are abysmal because of the poor performance of equities over the selected period (1998-2010) and consequently the fact that investors have paid a lot in 2% management fees and received little upside in the way of gains.
- JumpCrisscross 15y agoWe also have to marry this to the reality that most hedge fund managers have around 2/3 of their net worth in their funds. When markets crash you see more redemptions from bad funds than good funds; by only observing redemptions the good are ignored and bad are counted. Since those funds are still charging asset fees, the numbers are probably distorted towards 100% the worse the preceding period's equity market performance. Are hedge fund structures in need of reform? Probably. Do we need to warp and mis-represent statistics to accomplish this? No. Bottom line is that saying that the ratio of cash out to operators to cash out gross is 84% is meaningless given that it has survival bias built in - in the inverse. Bad funds who dissolve and result in massive outflows are over-represented. Those that succeed and hold capital, e.g. Berlshire Hathaway and Renaissance'a Medallion Fund, are ignored. I'm just imploring the HN community to remain objective, even when bad evidence seems to agree with our pre-conceived notions.
- Tycho 15y agoI don't understand what the article is talking about. Hedge funds traditionally take 20% of the profits from their investments. They also pocket 2% of the money that investors put into the fund (and 2% of it again when they withdraw), but I don't see why this would be classed as 'investment gains.' It's just more money they've been given to manage.
- JumpCrisscross 15y agoI posted a more complete thought as an independent comment, but essentially, by focussing on redemptions Lack'a analysis ignores un-realised gains. By this logic, Berkshire Hathaway has paid out less in dividends (zero) than accumulates compensation to its staff (since we are noting all cash receive by the fund as manager compensation, research and office space be damned).
- mbesto 15y agoI have such a hard time understand investing on this scale. Who the heck are these investors that continue to put money in these funds? Are there really that many wealthy people/organizations that are duped into the fallacy of hedge fund returns? This also reminds me of the idiots who paid into the Groupon investment just so they could pay off the original investors (who happen to be largely the Groupon CEO): http://www.bloomberg.com/news/2010-12-30/groupon-has-raised-500-million-of-950-million-it-sought-in-funding-round.html http://www.bloomberg.com/news/2010-12-30/groupon-has-raised-... When a market is littered with this much "loss" doesn't it eventually adjust?
- DarkShikari 15y agoThis also reminds me of the idiots who paid into the Groupon investment just so they could pay off the original investors (who happen to be largely the Groupon CEO): http://www.bloomberg.com/news/2010-12-30/groupon-has-raised-.. http://www.bloomberg.com/news/2010-12-30/groupon-has-raised-.... See http://en.wikipedia.org/wiki/Greater%20fool%20theory http://en.wikipedia.org/wiki/Greater%20fool%20theory .
- 3pt14159 15y agoThe idiots are eventually the public. Pension funds are major investors into hedge funds.
- asmithmd1 15y agoYes, the poor performers who pay their employees more than they contribute go out of business -- or get bailed out and stay in business.
- bolu 15y agoWell, just like the average retail investor buys last year's hot mutual fund in the hopes that (usually lucky) outperformance persists, institutional investors also got sold the "look how well my fund did last year" spiel. But before we think to ourselves "I'd never do that - I know that past performance doesn't have predict future returns..." look at the performance of the super popular Fidelity Contrafund (FCNTX) vs the S&P over the last ten years: 60.09% FCNTX 13.58% .INX (S&P500 Index) You know that investors every day are being sold this fund using this stat, and (the data shows) buying it.
- webnographer 15y agoI am an expert coin tosser :) If you have 1000 people tossing coins some of them will become experts at tossing heads every time.
- mahmud 15y agoGreetings fellow disciple of Taleb! :-)
- siavosh 15y agoThere's at least one big fallacy in this post: "This is a tiny fraction of the 1% fleecing the rest of the 1%." This is dangerously inaccurate. A significant portion of hedge fund assets are from institutions not wealthy individuals. This includes government assets (from local to federal), college endowments, pension funds etc. If the analysis is correct, this is a tiny part of the 1% fleecing all of us, and your parents too.
- guelo 15y agoI don't know enough to be sure one way or another but when Bernie Maddof's fund collapsed it did seem like it was mostly just rich people who lost money. Also it seemed like clients were obtained via personal relationships, not any kind of market exchanges. But I don't know if that fund was typical or not.
- siavosh 15y agoHedge funds typically cater to two different types of clientele. In Bernie Maddof's case it was probably mostly private wealth management. The other is institutional money.
- 2arrs2ells 15y agoQuite a few nonprofits and foundations had money invested with Maddof, and he was a rather sketchy money manager. Many (most?) universities have some funds invested with hedge funds (as well as VC funds and PE funds).
- wallflower 15y agoYou can make the argument that Harvard is an unregulated hedge fund. "I say get rid of exemptions on profits while keeping the charitable deduction for donors. Why should Harvard be tax-exempt on the dividends it receives from Microsoft or IBM stock, when everyone else is taxed on that dividend?" "So, in my mind, Harvard is a hedge fund that has a relatively small, money-losing education business on the side. I can see a justification for an endowment in a world of uncertainty when there are “bankruptcy costs” associated with the failure of a non-profit. However, large endowments are disturbing and are possibly evidence that a non-profit has not followed a zero or negative IRR strategy." Excerpts from the comments, not from the article http://marginalrevolution.com/marginalrevolution/2008/05/what-should-be.html http://marginalrevolution.com/marginalrevolution/2008/05/wha...
- kevinrpope 15y agoIt seems that this sensational headline (and the subsequent article) leaves out a main point as to why this would be happening: performance fees paid prior to 2008. Assuming the 2/20 fee structure, HFs would have taken 10 years of 20% fees on their performance before 2008 knocked out (according to the article) all of the returns for the previous 10 years. That would leave the investors back at 0, minus 10 years of 20% performance fees and 2% management fees. Given the time frame, I'm surprised the fees aren't greater than the realized gains.
- yummyfajitas 15y agoIt's also worth noting that many funds make performance feeds contingent on long term returns. So for the funds in question, if 2008 knocked out all their returns, they can't collect performance fees again until they have fully recovered from 2008. I.e., no more performance fees until the fund recovers from 2008.
- DevX101 15y agoThe managers are more likely to close the fund, open up a new fund under a new name and start the game over again. From this morning: http://darien.patch.com/articles/collapse-of-darien-hedge-fund-threatens-kentucky-state-pensions http://darien.patch.com/articles/collapse-of-darien-hedge-fu... http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2012/01/03/bloomberg_articlesLX89WS6K50YJ.DTL http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2012/01/03/...
- forensic 15y agoA lot of reasonable, sensible, intelligent, math & business oriented people saw this coming. I surely did and I'm not a financial professional. Financial products are basically snake oil there to enrich the salesmen at the expense of the clients. The clients eat the losses, the salesmen eat the gains. The stock market in general is a rigged game there to enrich insiders and salesmen. The reason financial products proliferate is because a sucker is born every minute and most people are too unimaginative to see alternative avenues of investment. It's not a productive industry. It's snake oil at best and more realistically is just a giant parasite on the economy.
- wtvanhest 15y agoWhen I first saw this post my initial reaction was... The data must be wrong, it doesn't make sense! I thought about it, and thought about it, then I realized it makes perfect sense. Hedge funds as an asset class should net to zero. Meaning, there should be zero profits on average from Hedge Funds. Since hedge funds hedge, meaning they supposedly eliminate the effect of market movements, the aggregate of all of them should be zero. Overtime, the bad managers loose their clients money and shutter and the good managers make billions. Mutual funds should net to inflation. Anything above zero for hedge funds and inflation for mutual funds represents alpha. (alpha is the additional return the manager returns). It makes sense that if the industry is returning any profitability to their investors they should be paying a fee. If you pick the right hedge fund manager, you should make excellent returns. Picking the wrong manager results in you taking gigantic losses. Even the best managers only make 20%+/- in addition to a carrying fee. But, the loosing managers suck the other profits out in carrying fees and losses. I'm not sticking up for hedge fund managers, but I think it is important to note that it makes sense that 87% "of profits" go to managers after you take out the losses and lost fees on shuttered funds. Winning funds still only take 20%ish of profits.
- xefer 15y agoThat's what the name "hedge" originally meant but for the most part they are pure investment vehicles now.
- wtvanhest 15y agoAll hedge funds are investment vehicles. All hedge funds hedge in someway. Many hedge funds hedge different types of risk. Most risk they hedge is market risk.
- pyoung 15y ago"Mutual funds should net to inflation." Are you forgetting to include economic growth in your analysis? Historical long term returns of the major indexes are in the 10% range (ballpark approx.), much higher than inflation, which I think was in the 2-3% range (also ballpark).
- mynameishere 15y agoYeah, and it's trivially proven. To the extent that hedgy X captures alpha, hedgy Y will not, and since they are both representing the same class of rich suckers, the only money gotten is the rake, aka, the 2-and-20 fee structure: mathematically the only people who can win are the funds themselves. Nothing complicated about it.
- solutionyogi 15y agoSomething does not add up. The author is claiming that between 1998 and 2010, managers earned between 379 billion in fees. Generally, hedge funds operate on 2/20 model i.e. 2% of the assets as the management fee + 20% of the profits. [Obviously these varies across hedge fund but for now, let's assume everyone follows this model.] E.g. If I give a hedge fund 100MM, they would charge me 2MM to manage it. Let's say they generate 10MM in profit. They will take 20% of that 10MM as performance fee. So to get 8MM, I will be paying them 2MM + 2M = 4MM which is 40% of the profits. Now that's clear, let's run this logic on author's numbers. Let's assume equal distribution which means that hedge fund earned around 30 billion in fees per year. (379 billion divided by 13 years between 1998 and 2010). If 30 billion is 2% of the assets, it means that they were managing 1500 billion dollars. The biggest hedge fund in the world, Bridgewater Associates, manages 125 billion dollars. There is no way other hedge funds can account for the remaining money.
- Bricejm 15y agoIt's a big market. http://www.hedgefundsreview.com/hedge-funds-review/news/1938356/total-hedge-fund-assets-grow-usd25-trillion-2011 http://www.hedgefundsreview.com/hedge-funds-review/news/1938...
- sakai 15y agoIndeed it's not at all unreasonable that the largest firm would be < 1% of the market. In fact it's fairly logical, given that: A) hedge funds are pursuing strategies where the individual investment opportunities are often fairly small (this is taken to the extreme in high frequency trading with many trades each yielding small returns), and; B) funds typically adopt a small number of strategies (e.g., 1) Consequently it's more difficult for large funds to find consistently good investments and thus there's a proliferation of small(er) funds. (Alternatively, if you believe in the Efficient Market Hypothesis much of individual funds positive or negative returns are dumb luck. It's then simply a matter of the fact that the probability of a fund having consistently positive returns -- and consequently having $125bn AUM like Bridgewater -- are exceedingly rare.) (Edit: extra text deleted)
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- zallarak 15y agoIf the markets [or the managers] performed better, a higher proportion of investment gains would go to the investor. As mentioned in this thread, fund managers are compensated based on a % of AUM and a % of profit, such as 2% and 20%. When the fund loses money, investors are the only ones that experience a net loss (the managers still net a % of AUM, or nothing at worst). If managers end up not losing money, the investor mathematically keeps a larger proportion of the gains. Also, when you invest in a fund, the idea is you are trusting someone else with your money. This article does not imply managers as shareholders. With this in mind, it does indeed make sense that in times of low performance and frequent losses that the people with no way to lose money end up keeping a greater proportion of earnings. EDIT: This might seem obvious, but its worth mentioning that in times of very good fund performance, the investors will keep an increasingly greater proportion of earnings.
- ericdykstra 15y agoTheoretically, hedge fund managers should make close to 100% of the gains over the market rate in fees. Otherwise, why would anyone invest in anything other than those funds if they're so much better than the market?
- tlb 15y agoFair enough: the managers did all the work and had all the brains. Investors in hedge funds were just hoping to get something for nothing.
- adamtmca 15y agoIf anyone is interested, "Inside the House of Money" is a pretty enjoyable book about "global macro" hedge funds in the mid 2000's. It's just a series of interviews with hedge fund managers about their careers, their favourite trades and how they run their funds. The interviews all take place prior to the financial crisis and it's neat to see how they were thinking about the economy. It ranges from "we're in trouble" to "I'm confused about what is driving the CDS market so I am on the sidelines." As for the story, I am totally apathetic. If you invest in a hedge fund you are well aware of the fee structure going in and you are a sophisticated investor. Ultimately these guys only make money if their clients make money.
- mikepmalai 15y agoI'd be interested to see the data and methodology used. 1998 to 2010 was a wonky period in the markets with both the tech and leverage bubble/bust, making any sort of estimate on performance/fees/assets tough.
- budley 15y agoThere is a glut of hedge funds, the best large ones are usually closed to new investors. In a year where many struggled of course fees v return looks bad. 2% of assets and 20% of gains is a steep price but it is cheap when you get one of the best. Pension funds don't do a good job of selecting managers and every man and his dog has opened one just to collect 2&20 rent on the money. Very few managers have an edge and it can be impossible to tell which ones do. All statistics on hedge funds are of limited value as the samples are incomplete and skewed - it is an information game after all.