1.6% & 18% is the New 2&20

Intriguing if slightly misguided article in the WSJ ( Hedge Funds Cut Back on Fees) about high fees that hedge funds charge, and how they have become somewhat lower. (My only beef with the article is that hedge fund under-performance has been going on for far longer than since the crisis).

As I noted in Romancing Alpha, Forsaking Beta, fees and performance are the two big issues facing hedge fund investors. It is nearly impossible to overcome the pernicious long term effects of 2&20%, assuming that funds have been out performing. But therein lay the rub: They haven’t been. So charging an enormous fee for under-performance seems to be rankling the big institutions who have been bamboozled by the consultants who push alternative investments.

Beyond fees, there is a real issue with hedge funds as investment vehicles. (And no, they are not an asset class, despite the claims of those over paid and conflicted consultants).

What are the problems that the hedge funds industry faces?

1. Most fund managers create Alpha only when they are small and focused — typically, under $250M.

2. When these funds scale up above $1 billion, there is a tendency to lose their advantages. Many become closet indexers (which at 2&20% is an awful deal)

3. The huge increase in the number of hedge funds — there are now over 9,000 — has dramatically diluted the manager talent pool.

4. The Mathematics of compounding fees is inescapable. The drag from 2&20 does not allow the advantages of market gains to accrue fast enough. That math is how the 2008 crash wiped out the prior 25 years of gains for Hedge fund investors (in total).

5. The odds are very long indeed that you will be able to select the next outperforming emerging hedge fund manager. Oh, and good luck getting the top 1% of funds — the best 80-100 performing funds — to take your money.

None of these issues cannot be cleared up with the disappearance of 7,000 hedge funds or so. That is not likely to happen so long as Institutions, family offices, and HNW investors keep plowing cash into them.



Hedge Funds Cut Back on Fees
WSJ, September 9, 2013

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