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A cliché in banking that your clients will be happy, in some loose sense of the word “happy,” to repeat back to you is that every bank has a league table showing itself as #1 in whatever thing it’s talking about that day. It’s a cliché because it’s true, and every banking analyst basically goes through a two-year apprenticeship in minimally justifiable league table slicing (“oh we can exclude that deal from the Americas league table because the company’s CEO spent a semester abroad in France during college” etc.). Once I spent some time flogging a credentials page that had us #2 in the particular thing I was hawking, which caused lots of delighted ribbing from clients (“Ha! I know this must be true* because it’s the only time a banker has ever showed me a league table where he wasn’t #1″) and also, indirectly, my realization that I was a terrible banker. Anyway, living in that world leaves you pleasantly desensitized to data: “oh sure,” you think, “Bank X is #1 in investment grade underwriting, but only because that’s what the data says; we just need to get some different data.”
Unlike on the buy side, where objective performance is the only measure and can’t be fudged. Hee:
Hedge fund managers pocketed 28.1 percent of profits generated by their funds over the past 18 years, new research from London’s Imperial College found.
The research, commissioned by KPMG and hedge fund industry body the Alternative Investment Management Association, found investors’ share of annual profits delivered by hedge funds from 1994-2011 was 71.9 percent.
It also found funds delivered an average annual return of 9.07 percent from 1994-2011, compared with 7.27 percent from global commodities, 7.18 percent from stocks, and 6.25 percent from global bonds.
“This research … disproves common public misconceptions that hedge funds are expensive and do not deliver,” said Rob Mirsky, head of hedge funds at KPMG in Britain.
The study, which assumed average hedge fund fees of 1.75 percent and performance fees of 17.5 percent, followed the publication in January of ‘The Hedge Fund Mirage’ by fund manager Simon Lack.
The book, which prompted a swift rebuttal from the hedge fund industry, said hedge fund managers themselves had earned 84 percent of returns delivered by their funds from 1998-2010.
Here is the paper, it is fun, what is not to like? It reports that hedge funds (1) generate above-market returns, (2) provide ~4% a year of alpha, (3) are pretty uncorrelated with other asset classes, (4) as part of a complete breakfast diversify your portfolio and improve your Sharpe ratio, and (5) have probably cured cancer but haven’t told us yet because they’re so modest.
Is it true? Meh, I suspect it is exactly as true as The Hedge Fund Mirage, which is to say, there are some numbers that are based in fact and some numbers that they forthrightly made up (for instance, they assume 1.75-and-17.5% fees), and both the real and fake numbers are directionally plausible in themselves, and when you smoosh them all together (and thereby multiply the uncertainties around the real and fake numbers) they generate a series of numbers that you can’t complain about too much but that at the same time doesn’t exactly fill you with the inner peace that you’d get from, like, physics. But you can’t complain about this chart:
I mean. You could, if you were churlish, complain. You could say things like “ha, it’s kind of funny that they decided 17 years was the appropriate timeframe; nothing arbitrary about that.”** You could perhaps have a bigger complaint, which is that this study compares the equal weighted HFR index of hedge funds – i.e. an index that equally weights the returns of the tiniest and biggest hedge funds that report to a commercial database, which probably excludes both abject failures / fake stock-picking robots and also as they put it “hedge funds with superior performance may not choose to publish their returns, due to the fact that they already reached their target size or they prefer not to reveal their returns to their competitors” – with market-weighted stock, bond, and commodities indexes. You might just guess that asset-weighting would drive down hedge fund returns – it would seem to in mutual funds anyway, though mutual funds lack a Bridgewater, and incidentally GOOD LUCK TODAY GUYS – or, conversely, that equal-weighting would drive up stock market returns – as in fact it does.***
More fundamentally, you might wonder if comparing (1) the returns that investors on aggregate actually get**** by plopping money in an actually investable thing like the world’s stock markets to (2) a time series of noninvestable numbers that are a statistical artifact dimly related to something that some but not all hedge funds reported is … sort of a weird comparison.
But that is missing the point because this is not a real thing; it’s a marketing thing. It’s barely even a real marketing thing – actual hedge funds presumably need to market based on their own measurable returns, not aggregated hand-wave-y industry returns, though you could imagine Marl Version 2.0 advertising based on this. Instead, it’s an industry PR pitch, which is to say that it is perfectly appropriate for it to be pitched at the level of fuzziness where investment bank league tables reside. The one truth of which I am completely convinced is that hedge fund managers in the aggregate have not pocketed either 28.1% or 84% of the profits generated by their strategies over the last 17 years. That’s just what some data says. If you’d prefer a different number, you can get some different data. Have I mentioned that I really, really look forward to hedge fund advertising?
* It wasn’t, particularly.
** Nah, I kid, there’s a good reason: “Following the standard methodology in hedge fund performance evaluation studies, we examine the post-1994 period. The reason is that commercial database vendors such as HFR and Lipper TA SS started to collect information about inactive hedge funds at the beginning of 1994. Put differently, our hedge fund performance analysis is executed using both active and inactive hedge funds, suggesting that we can obtain accurate estimates for hedge fund performance.” Seems reasonable.
*** Here is the S&P 500 index vs. the S&P 500 equal-weighted index from 1994 to 2011, via Bloomberg:
Eyeballishly SPX is like 2.5-3x where it started, SPW is almost 4x, vs. like 2.5x returns for “Global Stocks” and 4.5x returns for “Hedge Fund Index” (and 6x returns for “Equity Hedge”) in the chart in the text. So it makes up some of the difference. Go buy equal-weighted S&P, you can’t lose, this is both investment and legal advice, etc.
**** Or do they? I enjoyed reading this.