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?

Centre for Hedge Fund Research paper – The value of the hedge fund industry to investors, markets and the broader economy [AIMA]
Managers pocket 28 pct of hedge fund profits – study [Reuters]

* 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.

Comments (24)

  1. Posted by Guest | April 24, 2012 at 4:21 PM

    I'm just passing time waiting for the AAPL numbers.

  2. Posted by Bayou LP | April 24, 2012 at 4:24 PM

    "Unlike on the buy side, where objective performance is the only measure and can’t be fudged"

    Eh, not so much.

  3. Posted by Thomson Reuters | April 24, 2012 at 4:28 PM

    Footnoting League Table:

    #1 Matt Levine

  4. Posted by J. Paulson | April 24, 2012 at 4:55 PM

    "this is both investment and legal advice, etc."

    Sweet, I'll take it!

  5. Posted by Greg Smith | April 24, 2012 at 5:04 PM

    "my realization that I was a terrible banker."

    I know that feeling.

  6. Posted by PermaGuestII | April 24, 2012 at 5:08 PM

    Don't quite get the point of the whole "hedge funds are evil because their fees are too high!" argument anyway. Seems like if you don't like paying 2-20, the solution is to not invest in something w a 2-20 fee structure.

    I don't like travelling by bus, but I don't sit around bitching about the existence of the Port Authority Bus Terminal.

  7. Posted by UBS Derivatives | April 24, 2012 at 5:15 PM

    I believe you're missing an "out" there good sir.

    -UBS derivatives trader looking for someone to make him a market in all of these outs that he bought from some guy at GS who said they were all the rage.

  8. Posted by UBS Derivatives | April 24, 2012 at 5:30 PM

    Also, what do you have against traveling by bus? It's a great way to get around, a bit pricey, but worth every penny.

  9. Posted by Guest | April 24, 2012 at 5:51 PM

    tell that to the teacher whose pension throws its money into whichever HF gives the PF manager the best tug job.

  10. Posted by Heroin Futures | April 24, 2012 at 6:35 PM

    This is one of the most tired topics in investing. If you are dumb enough to think you can't beat the market, you are probably right.

  11. Posted by guest | April 24, 2012 at 9:15 PM

    I'm gonna go ahead and argue that the equal-weighted S&P vs. S&P graph is a spectacular argument for active management, in and of itself. I'll pay 2 and 20 for an equal-weighted ETF, which is kinda/sorta what long-short equity managers do anyway, in a roundabout, more concentrated sort of way (e.g., they short what's expensive and buy what's cheap). I mean, I'm not sayin', I'm just sayin'.

  12. Posted by Guest | April 24, 2012 at 10:23 PM

    You, sir, are an idiot.

  13. Posted by Beta Manager | April 24, 2012 at 11:18 PM

    Not professional what you said. It looks like PermaGuestII actually takes what he wrote seriously.

    Attention all asset gatherers, all on board for the the Beta train!

  14. Posted by Guest | April 24, 2012 at 11:29 PM

    "tell that to the teacher whose pension throws its money into whichever HF gives the PF manager the best tug job."

    1. Fire/sue you pension manager.

    2. Can't say I've ever heard of a pension manager throwing *all* his money into hedge funds. Even hedge funds say they're only supposed to make up a portion of your investments.

    3. Why would a pension manager invest in hedge funds for unethical reasons and yet not invest in other entities for unethical reasons? How are hedge funds the problem here and not the pension manager?

  15. Posted by Guest | April 24, 2012 at 11:46 PM

    The thing is, I'm really not.

  16. Posted by george37 | April 25, 2012 at 9:56 AM

    such a joke to try to pass a marketing document like that as an academic study, when it doesn't even account for survivorship bias (which some studies say adds 5%+ per year to the HF indices) or money-weighted returns- it says absolutely nothing about investors true experience in hedge funds so far

  17. Posted by george37 | April 25, 2012 at 10:05 AM

    Its crazy that something like LTCM isn't in there, at least in money-weighted form. That was a giant chuck of HF assets when it went down, and these indices hardly show a drawdown in the late 90's

  18. Posted by george37 | April 25, 2012 at 10:18 AM

    the better solution for institutions is to negotiate lower fees and structures that better align interests and where you aren't paying mostly for beta. clawbacks, hurdles, etc

  19. Posted by Guest | April 25, 2012 at 11:24 AM

    1. That's just a punishment after the fact. The employee is worse off when a CEO gets sued, the pension loses money and some HF collects fees. The former CalPERS CEO is getting this treatment as we speak, but that doesn't do anything to get the money back.

    2. I don't know what this has to do with anything. Did you think pretending i said "all" would somehow make it so? Needed to make up something because business school told you arguments are best made in sets of three?

    3. Exorbitant fees. The more money that can be siphoned away though fees, the more of an incentive there is for unethical conduct. Both entities are crappy when they come to an arrangement like this, but if one side has to get busted, it's easier to fix the ill-regulated high-fee Hedge Fund industry than it is poorly managed pension funds.

  20. Posted by Guest | April 25, 2012 at 1:16 PM

    1. So you're supposed to fire/sue the manager or punish the hedge fund *before* you find out whether they did anything wrong?

    2. You said "throw its money." You didn't say "throw part of its money."

    3. Nice theory. It flounders on facts. The banks engaged in far more shenanigans than hedge funds did over the past few years. It's also a rare manager or sales guy who has the option of trying to entice pension funds with hedge funds or mutual funds or some other vehicle. It's a question of getting the money or not. It's a question of increasing your income or not. If you're already getting paid exhorbitantly, you are (with some exceptions) less likely to mess it up by engaging in this stuff. The incentive belongs to the vehicles that perform poorly. They're the ones who need it and for all their problems, hedge fuNds have been performing better than most.
    This is aside from the fact that has required fixing over the past few years has largely been what's been ignored: the banks. Hedge funds weren't on the verge of destroying the economy. The banks were. Hedge funds weren't too overleveraged. The banks were. The hedge fund industry didn't need bailouts. The banks did. How in the world are hedge funds easier to regulate than a pension like Calpers which is state controlled?

  21. Posted by Incitatus | April 25, 2012 at 3:51 PM

    Now, now, don't disturb his unfounded populist rhetoric. It's warm and comfy, and sounds pretty darn intellectual to all of his (charmingly ignorant) peeps.

    -Dude Who Weeps for the Future

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