Fair enough assessment. For a fund that is all distressed (or all anything less liquid), the marks may have significant deviations from some sense of fair value. Investors would be wise to assess liquidity and transparency of the underlying investments and the manager's policy on obtaining fair marks.

Sorry, if that read as a contradiction to your post. I was just giving my own assessment.

I'll ask a few questions as well: Do you think the future of the fee structure will change? I think there should be increasing pressure on alternative manager's fees as the capital management landscape is becoming more competitive (but not to the point where I would consider asset managers a short).

How do you think the economics of the industry will change over time? What are the biggest threats and opportunities for asset managers?

It appears you have some equity ownership in the GP in addition to your net worth invested in the LP. How did you get your equity? Did you buy in as a partner? Do you receive equity as a bonus?

What famous manager do you most admire (or are similar to)?

What are the most rewarding and challenging parts of your job?

Best idea - past or present?

SEC should do what it thinks best for society. That is there job.

Reporting offers information to the public which likely has some positive benefit (though it is hard for me to judge how valuable this is) and it imposes some cost on hedge funds and others who must report in that they give up some "intellectual property"--which might slightly reduce their incentive to do research (which is a societal good in my view).

Not sure either effect that large to be honest, so I don't lose that much sleep over it.

Will the S&P be higher or lower in three years?

Do you think in any 15 years period, anyone who sit on the sidelines and park the cash in Treasurys until the next crash, and then splurge on cheap stocks, holding till next interest rate hike cycle could easily outperform 90% of hedge funds?

a few things on this--

Malkiel, who you cite as one of the sources of this, made his fortune writing a book saying markets are efficient (or largely so). His incentive is to find evidence to beat up hedge funds--another biased source.

Are you arguing that head funds that have edge do not exist? To be fair I have not laid out my case on this (yet) but I think I can convince most people when I do. If some funds exist that have edge (fee beating edge), then those funds do provide above average returns for more than just the people who run the fund.

If you review the thread, I have hardly argued that every hedge fund is worth investing in. I am arguing that some are (including mine), and with a fair an open mind you might agree.

Another point--to continue poker analogy, I would imagine 75% (or much higher percentage) of all people who set out to be poker professionals are no longer doing so. And staking EVERY player who wanted a staking deal would likely not worked out too well. But if Phil Galfond offered you the deal I discussed earlier in the thread, you should happily take it! The fact the the "poker player staking index" has had negative returns should not stop you.

Further--some hedge funds close even after being profitable. They may have existed to take advantage of a certain opportunity, made money, and closed. I know hundreds of such funds. There are other reasons why profitable funds close as well, but won't beat this horse too much further.

Survivor bias is clearly on average an adjustment down for the total return of some mythical "total hedge fund index" but might not be as much as those authors believe and, in any case, is irrelevant to the argument that SOME funds do justify their fees.

The best way to find evidence that survivor bias is not as large as the authors claim is to look back at one of those HSBC hedge fund reports discussed earlier from a year ago and from now. What percentage of the funds listed in that report 12 months ago are no longer listed in the most recent report? I would bet less than 7.3% have disappeared and to assume a 7.3% survivor bias adjustment who would have to assume that even if that were the case that each fund that shut suffered a 100% loss!

The Jack Schwager book, Market Sense and Nonsense, deals with this argument in far more depth. It argues that fund of funds returns suffer very little survivor bias (far less than the the pool of all hedge funds) so their returns are less vulnerable to Malkiel argument. etc.

But again, despite the fact that I have a hard to resisting, I am not really trying to defend investing in every hedge fund randomly, but saying some are worthy...

bump, in case you missed this

good luck sitting on the sidelines and then having the conviction to buy at the bottom or even know when that is.

Who is bottom picking? Actually there is no luck or risk involved when you are buying a basket of stock at 0.2 P/B and not borrowing.

I am not against OP but Hedge funds industry has underperformed S&P 500 years after years. Last year they lagged behind by 23 percentage points.

also interested in this

Not to be mean (this tone might be harsher than I intend), but this question is the equivalent of asking a poker pro to predict if the top card of a shuffled deck will be red or black.

I wish I knew---it would make my job a lot easier!

I must admit (negative tone coming again...apologies) I do get a bit annoyed with the comparing hedge fund returns to SP500 meme (always done in a year when the SP500 is up). Hedge funds should be creating (to be fair, not all do) return streams that are uncorrelated (orthogonal) to the SP500. The realized correlation to the SP500 in the fund I manage is almost exactly zero.

If you staked a poker player and he made you 20% on your investment, would you say he underperformed if the SP500 was up 50% that year? Would you be more happy with him if the SP500 was down 10%?

If the fund manager is truly uncorrelated, this analogy is appropriate.

Not ignoring this, but gearing up for a longer post on this topic...apologies for delay

this point really intererests me.
Could you name an example of a hedgefund that did exactly this?

I´m a big believer in the importance of "opportunity windows" and therefore
would be really happy if you could give me a starting point to do more research regarding this subset of hedgefunds.

Besides from that, this is one of the most interesting threads I´ve ever read on 2+2 and I thank you for doing this Q&A.

Looking forward to this response. Thanks for hosting this Q&A.

Thanks for coming here to answer questions.

1. There's a hedge fund that's actively disseminating negative information about HLF. How do you feel about getting actively involved in your investments? When would it be appropriate to:
a) vote your shares to influence management
b) try to influence public opinion

2. How do you feel about the idea of being long or short volatility? For the last few years being short volatility has been a very profitable trade.

3. When doing due diligence on a company. Do you think it's important to:
a) visit management
b) buy market research to see how well their products are expected to do in the market
c) focus on financials
d) other

Our company has several...they were designed for a certain opportunity, they worked and were shut down.

I have a friend who has solid, but not spectacular, returns who can't seem to get to critical mass in assets under management (AUM) who may just agree to join a larger fund.

There are also funds that do so well, the founder returns money and becomes a family office. The opposite of survival bias!

Now, to be fair, more funds close for the reason of bad (negative) performance--just making the point that the authors (Malkiel, et al) likely overstate the case, it seems to me.

And thanks for the kind words. It is encouraging that someone is enjoying my thoughts.

In addition to survivor bias (which I see you addressed), some of the criticisms against hedge fund returns that I have heard are the following, just wondering your thoughts on the matter:

- backfill bias, the idea that only successful funds get added to databases and report their good returns since inception while bad funds never get added and thus never report their returns
- forgot the term but basically not mark to marketing quarterly returns especially if assets are nonliquid. I think AQR had a paper on this that shows using previous quarters beta (or was it future quarters beta?) is a better measure than each individual quarter
- the idea that beta or standard deviation is a bad measure of risk for hedge funds in the first place since a lot of them incur non-standard risk exposures and thus exhibit returns that are similar to selling deep out of the money puts, even though they might not literally be selling deep out of the money puts

I have been long threatening, but failing to deliver, on a post detailing the record of Millennium Management (I do not work there). Here goes:

A Sharpe ratio (named after economist William Sharpe) is defined as

(return - risk free rate)/(volatility)

put another way, excess return/vol

While there are other ways to measure and discuss performance, this is a simple and straightforward one and is often used.

Sharpe ratios are most commonly discussed in terms of annual returns and annual vols.

If you have a Sharpe ratio of 1, you would expect to beat the risk free rate approx 5 out of 6 years (DUCY?)

If you have a Sharpe ratio of 2, you would expect to make money approx 43 of 44 years.

If you are just taking random risks (no edge), the odds that you would have a realized Sharpe ratio of 1 or higher in any one year period is approx 17% and less than 3% of over 2. Could happen though...there are a lot of hedge funds....

The odds of a random risk taker having a 2 Sharpe for 4 years is now 4SDs (2 * (sqrt(4)) or approx 1 in 15787

Millennium has has a 2.65 Sharpe for 16 years. Over 10SDs. Wikipedia stops at 7SDs (1 in 390billion)

There aren't that many hedge funds!

(and by the way, these are their returns AFTER fees. It would be their before fee performance you would want if were an academic debating whether markets are efficient or not)

But what makes Millennium track record even more interesting is how they do it.

Their model is to hire an army of different risk takers, screened by the firm to those most likely to have edge. They give these risk takers an initial amount of capital. If they do well, they are given more capital. If they lose money they have capital removed or are asked to leave entirely. They are asked NOT to coordinate with each other in order to prevent group think from making the teams correlated to one another.

It is basically a genetic algorithm for determining whether edge exists or not!

In the HSBC report there are many hedge funds with long track records at 1 or higher Sharpe ratios. Taking their Sharpe times the square root of track record length in years, you will find an awful lot of high SD outliers. Again, these numbers are all AFTER fees.

Unless every human has started multiple hedge funds (tens of billions of coin flippers!), it seems unlikely that the statement that "no hedge funds justify their fees" is defensible, in my opinion.

All of these are good points, but not enough I believe to fully blunt my bigger point.

Funds with illiquid securities likely have a slight upward bias in reported Sharpe ratios due to stale marks (which underestimates their true volatility--see private equity). But there are many funds with liquid securities and highly accurate marks (equity long/short, government bond arbitrage) who have accurate marks and high Sharpes over long track records.

Selling puts argument clever, but not enough again. Millennium and many successful funds existed and experienced 2008 (a fairly serious test) and their track records include performance through that time.

The idea that any hedge fund or any investor for that matter would have a quarterly "return" is asinine. People who play that game and gamble other people's money could never be trusted to be honest about anything in life. Period. Stock prices are unpredictable in the short term. In the long term, if the company does well the shareholders will do well.

Hedge Funds are basically gambling dens, where assets are gathered from other people who have created money mostly by adding value to society. Once these funds are gathered, Hedge Funds then look for gambles that can move the most, and that is why they pile into Krispy Kreme, Crocs, Netflix, and other trendy plays through the years.

Less than one percent of all people involved in hedge funds have a record of having huge success investing personal funds, having lived through ups and downs, and paid their living expenses knowing that if they made an investing mistake their would be real consequences.

There is no way to spin it. Hedge funds are about as ugly as it gets when it comes to finance and Wall Street (right there with CNBC, Cramer, Kudlow, and most other frauds). CNBC had/has a show called Fast Money. One of the biggest fraud shows on any topic that has ever aired. I haven't watched ten minutes since 2009, but I think the show is still on.

Just an average rant, even if someone is into rants.

I think the OP who has his own money invested in his fund deserves serious kudos for that.

Can you provide studies and facts to back up your evidence?

These seem like a bunch of anecdotal and made up facts.

I made up the "less than one percent of Hedge Fund people have had huge personal success investing before getting involved with Hedge Funds". I would bet my entire life against 1K that that is the case, though.

There are hardly any documented cases ever. It is far less than one percent, considering the number of people extracting money from the hedge fund asset gathering industry.

The biggest names are the biggest frauds of all time. Bill Ackman blew up Gotham Partners. He also blew one billion on Target calls...lol. Long Term Capital Management and John Merriwhether had the biggest collection of financial frauds as people ever assembled. VIctor Niederhoffer was great....lost it all multiple times. Cohen of SAC has insider trading scandals very close to him. I guess he is innocent of that. John Paulson, who engineered his personal trade against the mortgage market, made an ass of himself immediately after that, by maniacly gambling on anything that "might" move fast.

Very few people in history have had personal success investing (without leverage), and then gone into asset gathering. I'm sure there are some, but the number is so low that it isn't almost impossible to measure.

Even the mutual fund stars have been exposed as frauds. Bill Miller of Legg Mason might be the biggest fraud of them all. Remember Laurence Ariana and Hans Utch (spelling?). Those losers who were on every tv add for years. How about Janus Funds? Peter Lynch blew a ton of his personal money on Fannie Mae a few years ago. Went down with the ship, and bought more all the way till the end (just like Bill Miller). Google Bill Miller losses and see his horrific plays.

I'm not personally invested in this, but listing out ~15-25 names does nothing for me.

There are many reasons this is a bad argument, from the fact that there are 1000s of hedge funds to the fact that the hedge fund isn't ran by one guy, so even if the top guy has had a problematic history some of the main PMs might really be driving returns.

I don't necessarily agree or disagree with your premise, I simply haven't been even slightly swayed by your opinion on the matter. I'm not looking to start an argument or anything, so I'll step away but if you do have more evidence or a study on this I'd love to see it. Would also love to hear HFG opinion on the matter.