Hard Times at Hedge Fund High

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Edit: I wrote a post concerning the future of hedge funds sometime ago and it languished in the Drafts Folder. In the meantime, Ben Carlson of A Wealth of Common Sense posted this which is a far better and more concise explanation. I guess you have to be quick these days! So I’ll only summarize some additional thoughts here.

  • I came across this excellent link on twitter of a scanned Forbes article from 1970 entitled “Hard Times Come For Hedge Funds”. If you squint and I told you it was written last week, you might not notice the difference! It is my belief that history is a far better teacher than opinion. I highly encourage you to read it, who knows, perhaps we could see a resurgence in hedge funds (though maybe in 20 years).
    • For perspective, the largest fund in the article A.W. Jones Associates had AUM of $80MM which is about $500MM in today’s dollars according to dollartimes.com calculator.
    • The SEC has been ‘on the case’ since the 1970s regarding hedge funds!
      • “All are charged with having received “inside information” about Douglas (Aircraft) from Merrill Lynch, and with having them made sales and/or short sales of Douglas stock. The outcome of this case is still in doubt…”

    • Some of the comments are timeless/priceless:
      • “But now, to the immense regret of his limited partners, Buffett is quitting the game. His reasons for doing so are several, and include a strong feeling that his time and wealth (he is a millionaire many times over) should now be directed toward other goals than simply the making of more money. But he also suspects that some of the juice has gone out of the stock market and the sizable gains are in the future going to be very hard to come by. Consequently, he has suggested to his investors that they may want to take the ‘passive’ way out…”

      • “Hedging is vastly overrated as a concept. People argue that there is a psychological comfort in having a short position. I used to believe it, but I don’t any more. I stopped believing it after we got bloody and beaten from short selling.” – John Hartwell

      • “…each upwards of $30MM (~$200MM today) are run by former Jones men. These funds are sometimes jokingly referred to as ‘Jone’s children’… ” Tiger Cubs?

      • “During the month of June, when the market…dropped by 6.9%, hedge funds dropped on the average 15.3%. In July, when the market fell 6.4%, the funds were down by an average of 10%. And in August, when the market bounced back briefly, (the funds) averaged only averaged 4.2% gain, compared to 4.5% gain for the composite average”

      • “The market favored the shorts, and yet many hedge funds still lost money – or, at the best, made only a little – on their short positions. Some hedge funds say that 1969 had its special problems, among them the existence of too many hedge funds looking for shorts”I’d imagine crowding in longs too.

      • “In hedge fund terms, ‘Paris’ is the 20% of profits that goes to the general partners..” sweet, sweet Paris

      • “as one dejected investor put it, are ‘foolish’ enough to pay 20%…For as every hedge-fund manager knows, without a good product at a good price, you don’t get far in the market.” I guess snark existed in the 70’s too!

  • Originally hedge funds were a vehicle for High Net Worth individuals to juice up returns in their private portfolio. Given the growth of VC investments, I think there is demand for strategies that exhibit outsized returns and appetite for volatility. An aspiring manager today should embrace low capacity, high volatility, high return strategies and leave the low volatility stuff to the larger institutional funds that remain.
  • So why would the HNW market be more appropriate for a new or emerging manager? Basically it represents a good story. Imagine what rich people talk about in the Hamptons. Telling your contemporaries you have a balanced portfolio of ETFs or  a robo-advisor is boring. Booo. VC can be fun but probably not very profitable and that story is slowly losing its luster as well. Telling them you “got a guy” who uses Deep Learning and something called Hadoop is much cooler. (If this sounds sarcastic, it’s closer to the truth I think than at first glance)
  • Given the volatility and potential for large returns, the aspiring manager should be prepared to accept non 2 by 20 structures and forfeit carry for a higher payout on profit. An ‘eat what you kill’ payout structure something like a 0/50 model may be the norm for many managers or AUM at the 100-500MM level to operate in the low capacity space.
  • Hedge funds may be down, but I think this article shows that they are not out. I love finding historical precedence, it’s a much better forecaster IMHO.

Alongside a reduction in the active management business comes another aspect I think we will be hearing more about in the future; A large population of well educated, intelligent (but perhaps not creative) highly competitive, and prime working age individuals with no jobs. How many can be absorbed by the tech sector? Where will they all go?

StkChart70.JPG

DJIA Chart since 1960 for Reference

 

 

 

 

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