lunes, 27 de agosto de 2012

lunes, agosto 27, 2012



August 24, 2012 6:38 pm
 
The hedge funds are playing a loser’s game
 

The financial crisis trashed many reputations in the City of London and on Wall Street. But not those of the financial aristocracy – the hedge fund bosses. While the bankers took it in the neck for the carnage, some of the savvier hedgies – such as John Paulson, who made billions shorting the US housing marketactually saw their stock soar ever higher.




Other investment vehicles may have become pariahs but hedge funds have remained stubbornly fashionable. Since 2009, investors have pumped nearly $150bn of net new money into them, allowing the industry not only to rebound from the crisis but to resume its expansion. At last count, hedge funds managed $2.1tn in assets, more than they did on the eve of the financial crisis five years ago.



Among the most enthusiastic buyers of hedge fund services have been pension funds. Driven by the need to fulfil past promises made to beneficiaries, trustees have been prepared to punt ever more money on so-called alternative investments. Some US retirement funds intend to put up to 15 per cent of their assets into hedge funds in coming years against the 5-10 per cent many have invested now.




This is an ill-judged bet that gets ever harder to justify as hedge funds get bigger. For all its self-proclaimed brainpower, there is little evidence that the industry has the capacity to earn superior returns on the vast ocean of cash it already has at its disposallet alone all this new money. Even before the financial crisis, results were fairly lacklustre and they are worse now.




Far from carrying all before him, Mr Paulson is making thumping losses. Othermasters of the universe” – most recently Louis Bacon of Moore Capital – have been handing funds back to investors, in part because of the difficulty of earning satisfactory returns. George Soros, fabled as the “man who broke the Bank of England”, gave his investors all their money back last year.




Hedge fund bosses blame many of their difficulties on the dire financial environment and it is true that low interest rates and limited liquidity have conspired to crimp trading opportunities. But it is hard to avoid the impression that hubris is also a factor: hedge funds are now too big and numerous for their own good.




While the industry seems loath to accept the idea that there should be any limits to its size, there are clear problems associated with scale. It becomes harder to devise distinctive strategies. Funds find it more difficult to trade in and out of markets without moving prices against themselves.




An even bigger concern is that size has turned the industry into what is known as a “loser’s game”. This is one in which victory goes not to the player with the best offensive strategy but to the one who makes the fewest mistakes – and has the lowest costs. Hedge fundery has become a loser’s game because the funds themselves are no longer the exotic and small offshoot of mainstream fund management they were in the 1990s. Increasingly, they are the market.




Although hedge fund assets account for less than 10 per cent of investment funds worldwide, they account for a far bigger proportion of all trading on UK and US stock exchanges. The industry is increasingly engaged in a zero-sum game in which one fund’s profit is another’s loss, less the costs of the transaction. Given the high fees and trading expenses incurred by hedge funds, the majority are mathematically likely to disappoint.




This is not a problem the industry finds easy to address. Although some star managers such as Mr Bacon – may have the self-confidence to limit the size of their funds, many are beguiled by the industry’s lucrative fee structure into gathering assets without much thought as to whether they can put them to profitable use.




Discipline can only be imposed by outside investors. A good place to start would be to take a hard look at the way hedge funds report returns. This has obscured the size-related decline in performance.
.


.
The industry usestime-weightedfigures that simply record the return of each fund irrespective of how big it is. So a huge return on a tiny fund has the same weighting as a mediocre return on a giant one.



.
This, given the constant budding of tiny spin-off funds, which (if they report figures publicly at all) tend to perform well at least in their early years, has flattered the indices.


.
A better way to assess the merit of a hedge fund investment is to use a “dollar-weighted approach, meaning looking at what happens to dollars when they are actually invested. This is more akin to calculating a profit and loss account for hedge funds and, as such, takes size into account.




At the start of this year, Simon Lack, a hedge fund investor, performed precisely this analysis for the whole industry going back to the 1990s. The results were miserable. Mr Lack concluded that investors would have been better off putting their money in US Treasury bills yielding just 2.3 per cent a year.




Roughly 98 per cent of all the returns generated by hedge funds, he estimated, had been eaten by fees.



.
Tellingly, the Alternative Investment Management Association, the hedge fund industry body, has devoted a great deal of effort to rubbishing Mr Lack’s claims, recently publishing a 24-page paper (after six months of study) seeking to rebut his argument point by point. But far from demolishing his analysis, the series of quibbles the organisation ultimately offered actually (if unwittingly) reinforced it.



.
There are great hedge funds and investors have done well by backing them. It is not clear, however, that there would be many more such funds were the industry to have $3tn of assets rather than the current $2.1tn. “Large amounts of money under management and high fees spell eventual performance disappointment,” observed the late investor Barton Biggs. If the pension fund industry does not learn this lesson then it – and its beneficiaries – may face a rude awakening.



.
Copyright The Financial Times Limited 2012

0 comments:

Publicar un comentario