Are there 40,000 exceptional hedge fund managers out there?


Louise Bowman
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Despite their underperformance and high fees, investors are still, perversely, pouring money into hedge funds.

Speaking at the World Economic Forum in Davos earlier this year, George Soros seemed to be sounding the death knell for the industry he has dominated for so long.

“Since hedge funds are now a dominant force in the market, they can’t, as a group, outperform the market,” he said. “Outperforming the market with low volatility on a consistent basis is an impossibility. I outperformed the market for 30-odd years, but not with low volatility.” The numbers certainly seem to back him up. Recent research by BarclayHedge and TrimTabs Investment Research shows that the hedge fund industry as a whole underperformed in January, up only 2.5% compared with the S&P 500’s 5%. This follows a dismal year for the industry in 2012 when the S&P 500 was up 14% on the year while hedge funds managed just 7.8%. Despite this performance, however, the research – based on data from 3,459 funds – shows that the hedge fund industry took in $4.3 billion in January, compared with outflows of $20.7 billion in December.

Sol Waksman, founder and president of BarclayHedge puts this down to the macro risk environment. “Although assets did flow out of hedge funds and equity mutual funds last year, assets are flowing back now because there’s less fear that a major tail-risk event will destabilize western economies,” he says. It seems perverse that investors are keeping faith with the asset class given the growing criticism – even from among its own ranks – that its 2% and 20% fee structure is indefensible given performance.

“Hedge funds are simply writing puts on the S&P 500,” sniffs one London-based banker. "This masquerades as alpha until the market crashes, then it looks like beta."

There is growing disquiet even from within the ranks over hedge fund fees. Cliff Asness, co-founder of asset manager AQR Capital Management, has recently been vocal on the topic, stating that while hedge funds generally run portfolios comprising a mix of beta and alpha, they set their fees on the basis it is all alpha. Speaking at the University of Oxford’s Saïd Business School in March, Oaktree Capital co-founder Howard Marks supported this theme.

“Only exceptional people should get exceptional compensation,” he declared. “There are 40,000 people in 8,000 hedge funds making decisions and getting 20% of profits. Are there really 40,000 extraordinary people out there?” Given that the industry underperformed most other asset classes last year, the answer is probably no. “There needs to be a shakeout,” Marks said. Strangely, many of their investors don’t seem to agree.