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2012-07-10 08:41:35
Two books analyse what makes hedge-fund managers great and reach very different
conclusions
Jul 7th 2012 | from the print edition
The Alpha Masters: Unlocking the Genius of the World s Top Hedge Funds. By
Maneet Ahuja. Wiley; 245 pages; $29.95 and 19.99. Buy from Amazon.com,
Amazon.co.uk
The Hedge Fund Mirage: The Illusion of Big Money and Why It s Too Good To Be
True. By Simon Lack. Wiley; 187 pages; $34.95 and 23.99. Buy from Amazon.com,
Amazon.co.uk
FORGET the one percent denounced by the Occupy Wall Street protesters.
Hedge-fund managers have made so much money for themselves that they are in the
top percent of the one percent. The billions they have raked in make bankers
bonuses look titchy. Their vaunted success trading stocks, bonds and other
instruments has helped to transform a cottage industry into a behemoth; today
hedge funds oversee more than $2.1 trillion. A class of moneymen who once only
managed funds for buccaneering, rich families now count the world s largest
public pension funds and endowments as clients.
Have hedge funds succeeded because of their investment genius, or their crafty
marketing? Two new books disagree on whether the hedge-fund managers golden
chalice is half-full or half-empty. Maneet Ahuja, a CNBC producer who worked
briefly on Wall Street before taking a job at the Wall Street Journal, has
written a homage to hedgies. She was in awe of Wall Street already when she was
an intern at Citigroup ( I left the building with an offer for a semester
internship in hand, convinced I had found my calling with the good guys good
guys with nice shoes ). She has never shed it. The Alpha Masters profiles 11
of the industry s best-known bosses, and looks at their investment philosophies
and their famous trades. John Paulson made billions predicting the bursting of
America s housing bubble; James Chanos, a short-seller, disrobed Enron; and Ray
Dalio, the boss of Bridgewater, the world s largest hedge fund, makes a killing
for his investors and keeps calm doing transcendental meditation.
Throughout her book Ms Ahuja seems to be in a trance herself, in thrall to the
glamour of her subjects. She never questions the judgment of her alpha-men and
always gives them the last word. She devotes dozens of pages to Mr Paulson s
rise in the hedge-fund industry, but glosses over his poor performance in 2011.
His results have led some to speculate that he may have the unfortunate record
of both earning and losing the most money in hedge-fund history. She quotes one
of his 2011 letters to investors asserting that bank stocks whose struggles
pulled down his funds performance would rebound when the economy improves,
never criticising what he did or pointing out that investors will have to wait
ages to claw back such massive losses. Nor does she grasp at bigger themes or
the many common factors that hedge-fund managers share. Is it ego, courage,
good networks or charisma that has brought them more success than their fellow
financiers?
The Hedge Fund Mirage attacks the Wall Street worshippers blind adulation.
Simon Lack, who spent 23 years at JPMorgan, an investment bank, selecting hedge
funds to invest in, grew tired of the free hand that investors all too often
gave managers. He has written a provocative book questioning a central tenet of
the hedge-fund industry: its performance is always worth paying for. The
promise of superior performance is wrong, he says. Of course some investors
make a killing, but on average hedge funds have underperformed even risk-free
Treasury bills. This is because the bulk of investors capital has flooded in
over the past ten years, whereas hedge funds performed best when the industry
was smaller than it is now. What is more, it is hard to know how hedge funds
actually fare, since indices that track industry performance tend to overstate
the returns. Funds that do badly or implode are not usually included in the
indices at all.
Why would any client continue to pay for such mediocre returns? One reason is
that hedge-fund managers are incredibly good salesmen. In addition, industry
insiders who are all too aware of hedge funds shortcomings choose not to
expose them, Mr Lack argues. Moreover, the common fee structure, in which
hedge-fund managers keep 2% of assets as a management fee to cover expenses
and 20% of profits generated by performance, has made many managers rich, but
not their clients. Mr Lack calculates that hedge-fund managers have kept around
84% of profits generated, with investors only getting 16% since 1998. Where
are the customers yachts? is the title of one chapter. What is worse, the
disastrous dive of equity markets in 2008 may have wiped out all the profits
that hedge funds have ever generated for investors.
Mr Lack places a good deal of the blame for this on investors who fail to ask
tough enough questions and have not grasped that they want yesterday s returns
without yesterday s risk . They invest money with the biggest, best-known funds
that look nothing like those whose aggregate performance they want to
emulate. Instead investors should stand up to managers, negotiate more
favourable terms and put their money into smaller funds, which tend to perform
better.
Mr Lack points out that large institutional investors always like to invest in
bigger hedge funds. That way they need not worry about being the bulk of a
small fund s investor-base. But he offers no solution for these large
investors, who cannot put big sums into the small, nimble funds that he touts.
Nor does he analyse how hedge-fund performance compares with other asset
classes, such as private equity. As a result, the reader is left with a nagging
unanswered question: would investors do better to avoid hedge funds altogether
and, if so, where should they put their money in future?
In his conclusion Mr Lack argues that most hedge-fund books are written by
their proponents . His ambition was to spark debate and help to change the
industry. Whether he succeeds or not remains to be seen. Hedge-fund executives
have already reacted angrily to The Hedge Fund Mirage , which suggests that
looking into the mirror may be painful. They rightly worry the days of easy
praise are over.
from the print edition | Business books quarterly