Lack is no ordinary critic — he spent his career at JPMorgan Chase, where he allocated more than $1 billion to emerging hedge fund managers. Some of the statistics he amassed in the process are nothing short of astonishing:
●From 1998 to 2010, hedge fund managers earned $379 billion in fees. The investors of their funds earned only $70 billion in investing gains.
●Managers kept 84 percent of investment profits, while investors netted only 16 percent.
●As many as one-third of hedge funds are funded through feeder funds and/or fund of funds, which tack on yet another layer of fees. This brings the industry fee total to $440 billion — that’s 98 percent of all the investing gains, leaving the people whose capital is at risk with only 2 percent, or $9 billion.
What other concerns should investors have? Hedge funds are not especially liquid. Many are “gated” — meaning there are only small windows when you can withdraw your money. They typically have a high minimum investment and often require investors keep their money in the fund for at least one year.
Why would anyone in their right mind invest in these funds?
So many kids dream of becoming LeBron James, but most will never play in the NBA (to say nothing of amassing championship rings). So it also goes with hedge fund investors. Most of the more than 10,000 hedge funds out in the wild are not big moneymakers for their investors. Investors tend to discover “hot” mutual fund managers just after a successful run and just before the inescapable force of mean reversion is about to kick in. Similarly, hedge fund darlings are born at exactly the same moment in their trajectory.
John Paulson is a classic example. The bet against subprime mortgages that he and Paolo Pellegrini created in 2005-06 put them on the map and turned Paulson into a billionaire. He became widely known, and the money flowed in. Within a few years, Paulson was managing a slew of hedge funds, and his assets under management had swelled to $36 billion. Soon after, he hit the skids, with losses of 52 percent in one fund and 35 percent in another.
But the lure of the superstar manager — the guy who can make you fabulously wealthy – continues to attract capital. In 1997, $118 billion was managed by hedgies; as of the first quarter of 2012, that had grown to $2.04 trillion.
Investors have also embraced other non-financial remunerations: Client-only market commentary, access to star managers, attendance at exclusive conferences. These perks generate cocktail party bragging rights, despite the poor performance.
But what about the top-performing funds, such as Jim Simon’s Renaissance Technologies or Ray Dalio’s Bridgewater? Sure, give them a call.
The Lebron James of hedge fund managers are few and far between. This is the crux of the issue with hedge funds. A small percentage have significantly outperformed the markets; an even smaller percentage have done so after fees are taken into account. While we all know which ones have outperformed over the past few decades, no one has even the slightest clue which ones will outperform over the next one. It is akin to picking out from the ranks of high school sophomores who will be the next NBA superstar. Best of luck with that.
Every fund in the world warns that past performance is no guarantee of future results. It is too bad that investors refuse to believe it.
Ritholtz is CEO of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture.