Left for the investor that is.
It turns out that if you calculate how much money hedge funds generated BEFORE fees from 1998-2010, and then deduct hedge fund fees (and fund of fund fees) from the gross profits (that is, in excess of treasury bills since those are the only measure of returns that are worth anything) , the clients were left with 2%. Hedge funds have been highly profitable, but unfortunately the profits haven’t made it to the investors.
The industry kept 98%. Bloomberg presented a version of this chart on TV this morning. Hopefully the message is getting across. It’s not that there aren’t some great hedge fund managers out there – of course there are. But investors need to do a far better job of negotiating terms that allow them to share in that success.
Forbes – Chasing the Mirage of Hedge Fund Returns:
The industry is full of super-smart investors, some of whom have been able to generate superior returns. The problem is that a few dozen have produced most of investors’ returns, and as with actively managed mutual funds, it’s difficult to identify the strong performers in advance. Moreover, the persistence of compelling relative performance is not strong, market inefficiencies can quickly disappear, and the investing rewards are heavily skewed in favor of themanagers. As a result, the average hedge fund investor has not done as well over the years as the numbers might suggest.
The problem is labeled pretty straightforward. The hedge funds get their fees regardless of success, and always come out winners.
His conclusion: from 1998-2010 the index returned only 2.1% annualized on a money-weighted basis, not 7.3%. During that time frame, he estimates that hedge fund managers earned $379 billion in fees, while “real investors” earned only $70 billion in profits. Thus, the operators earned 84% of the investment profits and investors only 16%. But wait, there’s more. These figures don’t account for fund of funds, which add another layer of fees and through which around one-third of hedge funds are purchased. Including these brings industry fees up to $440 billion, or a whopping 98% of the profit pool, leaving only $9 billion for investors.
And to add insult to injury, Lack notes that HFR Global Hedge Fund Index returns are also overstated due to statistical biases such as “survivorship” (lousy performers shut down or stop reporting) and “backfill” (strong performers start to report). Academic estimates are that these statistical biases of self-selection (reporting is optional for the largely unregulated hedge fund industry) add 3-5 percentage points to index returns. Adjusting for these biases, Lack estimates that from 1998-2010 investors collectively lost $308 billion in hedge funds while the industry earned fees of $324 billion.
It’s all about presenting the right statistics.
hat tip Abnormal Returns