The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True
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The Hedge Fund Mirage
Hedge funds are set to deliver their second worst year in history, exceeded only by 2008, according to data from Hedge Fund Research. "For the ninth straight year, hedge funds will fail to beat a simple blend of 60% stocks and 40% bonds," says Simon Lack, Managing Partner at SL Advisors, LLC, and author of the new book The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True (Wiley; January 2012; $34.95; 978-1-1181-6431-0; Hardcover; Ebook). “The problem is that the hedge fund industry is overcapitalized,” Lack says. “Hedge funds have made tremendous amounts of money, but it hasn’t made its way back to the clients. In fact, if all of the money that’s ever been invested in hedge funds over the history of the industry had been invested in treasury bills instead, the results would have been twice as good.”
Lack exposes the truth about hedge funds: as a result of high fees, complex legal structures, poor disclosure, and return chasing, investors have ended up with meager results. Drawing on his insider view during the 1990s, a time when hedge fund investors did well in part because there were relatively few of them, The Hedge Fund Mirage chronicles the early days of hedge fund investing before institutions got into the game; describes the seeding business—a specialized area in which investors provide venture capital-type funding to promising but undiscovered hedge funds; reveals the surprising frequency of fraud, highlighted with several examples that Simon was able to avoid through solid due diligence, industry contacts, and luck; and examines why new and emerging hedge fund managers are where generally better returns are to be found, because most capital invested is steered towards apparently safer but less profitable large, established funds.
Dispelling the Myths of Hedge Fund Success
- The hedge fund industry has grown from less than $100 billion assets under management back in the 1990s to more than $1.6 trillion today.
- The top 25 hedge fund managers collectively earned $25.3 billion in 2009. Just to make it into this elite group required an estimated payout of $350 million.
- While hedge funds did well in the 1990s, since 2002, they have failed to outperform a traditional 60/40 portfolio of stocks and bonds. They are down 8.5% for the year; the overall U.S. Stock Market is down about 2% for the year.
The book also demonstrates how to identify the good hedge funds and keep more of the winnings that are generated using their capital. Lacks advises hedge fund investors to invest the way they did in the 1990s: look for smaller funds that are not well followed and utilize obscure and off-the-beaten-track strategies. The vast majority of hedge funds did better when they were smaller, and so did the industry as a whole. Careful due diligence is necessary to ensure the quality of returns, valuation procedures and other qualitative metrics are acceptable.
“Investors who can recognize what made the industry so successful will demand better terms, transparency, liquidity, fees, and information. They’ll redress the current huge imbalance that exists between the industry and its clients. By investing in hedge funds that look more like yesterday’s, they are likely to find the household name of tomorrow and get a fairer deal for themselves.”