Hedge fund humbugs

At the end of the Wizard of Oz the wizard is revealed not to be somebody of superhuman powers but “just a common man”, “a humbug”. Hedge fund managers are like that. Whereas their enemies, such as some of the posters on Wall Street Bets and indeed many on the left generally, sometimes pretend that they are evil geniuses the truth is much more mundane.

 Data from Hedge Fund Research tell us this. They show that the average hedge fund has made 5.6% a year in the last five years. That might sound OK. But you could have made twice as much by just leaving your money in a fund that tracks MSCI’s world index; over 10 per cent in gold; and 3.8% in US Treasuries. Which means reasonably balanced funds which any investor could create for themselves have done as well as the hedge fund; in recent years any fool could have been a decent asset allocator.

The average equity market neutral fund – the sort that takes short positions in stocks - has done worse than this, making less than 2% in this time.

Of course, some funds have done much better – but then, somebody wins the lottery every week – but others have done worse. Crispin Odey’s Odyssey fund, one of the UK’s higher-profile funds, has lost almost 50% since 2016.

Hedge funds, though, aren’t the only mediocre funds. Conventional equity unit trusts also do badly. The Financial Conduct Authority says these “did not outperform their own benchmarks after fees.” And David Blake and colleagues have concluded that (pdf):

Almost all active fund managers fail to outperform the market once fees are extracted from returns.

Hedge fund managers, like their conventional counterparts, are not great wizards.

If you believe the efficient market hypothesis – which says that all information is in the price and that you therefore cannot beat the market except by taking extra risk – this is just what you’d expect.

But there’s a puzzle here. As I’ve said for ages in my day job, there are two (and perhaps only two) well-attested ways to beat the market – by investing in defensive (pdf) stocks or simply in ones that have risen in recent months. We’d expect many funds to do well simply by adopting these strategies.

And yet they don’t. Why not?

Many do try to exploit momentum: several of the most shorted stocks in the UK are long-term munters such as Cineworld, Premier Oil or Metrobank. But it’s dangerous to short even bad stocks because their prices can jump quickly: in the first two weeks of November, for example, Cineworld’s price jumped 50%. Such jumps require shorters to put up more cash – the margin call, which, says Dan Davies, is “one of the most frightening things in the financial world.” Shorting is much easier in theory than in practice – which is one reason why markets are not fully efficient.

This, however, just raises the question: if hedge fund managers are duffers, why are they rich?

It’s because they are clever not at asset management but at asset gathering. They make their money from fees: why do you think they go to the hassle of dealing with clients rather than simply trading at home on their own account? Hedge funds typically raise money from other institutional investors who are managing it on behalf of you and me. And as Milton Friedman pointed out years ago, when people spend other people’s money on other people, “they don’t economize and they don’t seek the highest value”.

Many also benefit from a tax break: their fees are taxed at an anomalously low rate.

My point here is more about politics than finance. Our class enemy are not evil geniuses practising some arcane magic; investing successfully requires little intellect. Instead, they are beneficiaries of emergent processes such as principal-agent failures and deference towards the rich and of the cronyism  that gives them special treatment from the state. There are no wizards, just common little humbugs.

Comments

[rsm]

The fact that one firm wins the lottery every week belies the efficient market hypothesis. Medallion has averaged 39% for decades.

[aragon]

I think we know this: (common knowledge)

When the Government (BoE) pours £875Bn into Q.E and raises asset prices and lowers interest rates to zero. You need epic stupidity to loose money in Housing or Stocks and shares (If you already have money or assets).

Stupidity like announcing you are highly leveraging a short position on a stock. In which case even retail investors (collectively) can force you to liquidate your position at a enormous loss!

"The market can remain irrational longer than you can remain solvent."
J. M. Keynes.

Not to mention such obscenities as front running and high frequency trading.

It's long past time we took the rich/elites toys away. Retail Banking and the Stock Market, and Q.E. Asset Purchases.

Not too big to fail, too big to keep!

Echo Boomers (2020)
https://www.imdb.com/title/tt4353270/plotsummary?ref_=tt_stry_pl

"Based on a true story, five college graduates decide the best way to get back at the unfair economy and live the life they've always wanted is to steal from Chicago's richest and give to themselves."

[Bill Posters]

The data from Hedge Fund Research "consist of the largest 500 funds that report to the HFR Database, are open to new investments and offer quarterly liquidity or better." How much of the Hedge Fund Universe does this include?

Assume for a moment that the efficient market hypothesis is rubbish. That means somewhere someone is reliably making money out of the market for low risk. If you were in that position would you tout for customer funds. Unlikely, you would leaverage your own capital up and go about your business quietly. Your edge or niche won't last for ever in ever changing markets.

What about High Frequency trading and front running orders thats a hedge fund strategy which requires tech and priviledged access to trade data. When it works it's just part of the investment infrastructure which increases the vigorish for everyone else.

What about insider dealing, surely rife.

Sure on average Hedge Funds and actively managed investment funds perform less well than bench marks, but that average can hide a lot of success, let alone all the outfits that exclude themselves from the data.

[ltr]

February 3, 2021

Coronavirus

UK

Cases   ( 3,871,825)
Deaths   ( 109,335)

Deaths per million   ( 1,606)

Germany

Cases   ( 2,252,489)
Deaths   ( 60,212)

Deaths per million   ( 717)

[ Heartbreaking, and what should be politically intolerable but is evidently acceptable to Tory and Labour leadership. ]

[ltr]

Along with David Graeber, I watched in sadness as the British media slandered and ruined Jeremy Corbyn so that there would be no meaningful Labour leadership. Now I watch Tory leadership ruin a country I love, and British media is only intent on creating scapegoats.

[ltr]

https://www.nytimes.com/interactive/2021/02/04/world/europe/covid-vaccine-uk-rate.html

February 4, 2021

Vaccines Could Blunt U.K. Epidemic in Weeks
Britain is on track to deliver a first dose to everyone by the end of June. But vulnerable groups accounting for the vast majority of deaths could be vaccinated much sooner.
By Allison McCann

[ltr]

https://www.nytimes.com/2021/02/03/us/astrazeneca-coronavirus-vaccine.html

February 3, 2021

The AstraZeneca vaccine is shown to drastically cut transmission of the virus.
By Marc Santora and Rebecca Robbins

The vaccine developed by the University of Oxford and AstraZeneca not only protects people from serious illness and death but also substantially slows the transmission of the virus, according to a new study — a finding that underscores the importance of mass vaccination as a path out of the pandemic….

[ Really, really hopeful. ]

[Blissex]

«They make their money from fees»

And how much! Consider a personal pension fund "invested" in active funds: when the owner of the fund retires the recommended drawdown rate is 3-4% per year. The fees of 1-2% per year are charged not just in the drawdown period after retirement, but also in the accumulation period before retirement, which means that overall 40-60% of a personal pension invested in active funds goes to the City.

«they are beneficiaries of emergent processes such as principal-agent failures and deference towards the rich and of the cronyism that gives them special treatment from the state.»

Those "emergent" and "deference", and also mere "cronysm", are huge understatements: the City have lobbied the politicians for a long time to switch suckers from occupational and state pensions that cost very little (the fees on the NHS pensions are 0.5% rather than 40-60% of the pensions paid) to personal pensions funds, and it was a central aim of Thatcher and her successors to do so. Not coincidentally the UK has some of the lowest state pensions in Europe.

[Blissex]

«Sure on average Hedge Funds and actively managed investment funds perform less well than bench marks, but that average can hide a lot of success, let alone all the outfits that exclude themselves from the data.»

Please please please, the efficient markets hypothesis has been debated endlessly and these arguments have all been made before, and they are not that interesting because there are *several* different forms of it, ranging from weak to strong.

Your argument is against the partial straw man of one of the strongest forms of the hypothesis, the form that says "nobody can beat the market except over the short term". The better form is the weaker one, that "it is possible for a few to beat the market but not in general and reversion to the mean is inevitable". Consider as to "not in general":

https://www.ft.com/content/40b9b356-661e-11e9-a79d-04f350474d62
«Buffett agrees that he could do much better with less. “I think that if I was working with $1m or if Charlie [Munger, Berkshire’s vice-chair] was working with $1m, we would have no trouble earning 50 per cent a year,” he says.»

That is not an empty boast: that's exactly what he did at the beginning of his career, by working in the least popular regions of the stockmarket. As to the most popular (the S&P 500) in the same interview he says:

https://www.ft.com/content/40b9b356-661e-11e9-a79d-04f350474d62
«Asked if his expectation of “modest” outperformance against the market has changed in the intervening 20 years, he adjusts his forecast by a single word: “very modest”. “I think this: if you want to join something that may have a tiny expectation of better [performance] than the S&P, I think we may be about the safest.”»

[Blissex]

«The fact that one firm wins the lottery every week belies the efficient market hypothesis. Medallion has averaged 39% for decades.»

A commenter on "The Guardian" reported in 2018:

“I inherited two properties in 1995 [ ... ] and the value has gone from £95,000 to £1,100,000”

That is a a compound (gross of inflation and taxes and expenses though) return of 11% per year for 23 years, or an average gain of around £43,000 per year on a £95,000 initial capital.

If instead of inheriting he had bought them with a £5,000 cash deposit that would be a compound (gross of inflation and taxes and expenses) of over 25% per year, or an average gain of £43,000 per year on an initial cash deposit of £5,000.

All this without considering rental income. Without doing any stockpicking, or pretty much any work, and mostly tax-free, and pretty much risk-free thanks to an implicit government guarantee.

South-east property is the greatest financial invention ever!

[ltr]

February 5, 2021

Coronavirus

UK

Cases   ( 3,911,573)
Deaths   ( 111,264)

Deaths per million   ( 1,634)

Germany

Cases   ( 2,276,371)
Deaths   ( 61,661)

Deaths per million   ( 735)

[rsm]

Blissex: see https://twitter.com/TorrasLuis/status/1259827384611737600/photo/1

Asset markets outperform housing some five times over, at least since 2009.

You don't have to pick stocks, you simply invest in a S&P 500 index fund.

There is also an implicit government guarantee for stock markets.

[Blissex]

«Asset markets outperform housing some five times over, at least since 2009.»

Depends on the country...

«You don't have to pick stocks»

"MB" was making the argument that in order to get really huge "transformative" gains stock picking is necessary, and I agree with that, and was commenting on that.

«you simply invest in a S&P 500 index fund. There is also an implicit government guarantee for stock markets.»

The big difference is that you can buy property with 20 times levergage (cfr. Help To Buy 5% deposit) and that leverage is what is effectively government guaranteed, because many more voters are all-in for 20 times leverage on property speculation, but are not allowed to leverage their stock speculation.

Property in the UK is so important the even the Chief Economist of the Bank of England recommended to savers in an interview to liquidate their stock based pensions to buy property instead:

http://www.theguardian.com/money/2016/aug/28/property-is-better-bet-than-a-pension-says-bank-of-england-economist
«Haldane believes that property is a better bet for retirement planning than a pension. “It ought to be pension but it’s almost certainly property,” he said. “As long as we continue not to build anything like as many houses in this country as we need to ... we will see what we’ve had for the better part of a generation, which is house prices relentlessly heading north.”»

That caused quite a reaction, but he is still the Chief Economist of the Bank Of England, so obviously that was the official line. Strange times when the Bank of England itself is willing to throw the stockmarket under the bus to boost property prices, but that is a measure of how politically important it is to keep leverage property speculation more profitable than stock speculation in the UK at least.

[Blissex]

«You don't have to pick stocks, you simply invest in a S&P 500 index fund.»

Also as to the context, your specific example was:

“one firm wins the lottery every week belies the efficient market hypothesis. Medallion has averaged 39% for decades.”

Choosing that fund out of all funds is stock picking, and in addition that fund also does stock picking. Investing in property is a lot simpler: buy on 20 times leverage in any "southern tory" area with momentum. Millions of people have done that without much effort, and have "won" big capital gains and are smug about their "investing skills".