We've written before about some of the issues with Hedge Funds that are less than desirable for prospective investors, especially the fee structure which creates an element of moral hazard. Even more egregious are the "Funds of Hedge Funds" (FOFs), which charge an additional layer of fees for the "value-added" of selecting individual funds and combining them into a basket.
FOFs were designed to accomplish several objectives that an individual investor might not have the resources to achieve on his or her own. They pride themselves as "experts" on each individual fund by performing extensive due diligence and detailed statistical analysis of their return profiles. In addition, they create better diversification by placing 10 or more funds in a pool. Investors are also given access to funds that have closed to new investment, except through the fund baskets.
Great concept in theory, but like so many others, often fails miserably in practice.
FOFs, for their services, usually charge both an additional management fee and often take a modest performance fee. The hedge fund norm is a 2% management fee combined with a 20% performance fee. The FOF often adds another 1% and 10%, respectively, brining the total to a very steep 3% and 30% of profits. This fee structure, in a world of single digit returns, makes the entire FOF concept ensure that investors will achieve sub-standard returns.
In addition, despite the claims of great due diligence, so many FOFs have been caught in manager wipe-outs. Industry fixtures Tremont and Ivy Asset Management, two firms that were former clients, both got trapped by Bernie Madoff. In fact, every hedge fund manager meltdown, beginning with Askin Management in 1994, Long-Term Capital Management in 1998 and then the slaughter in 2008-09 has exposed the weaknesses of the FOF industry.
The bloom is off the rose. In year-end 2007, FOFs represented a massive 43% of assets. Currently, it is down to 34% and shrinking. FOFs have a growing list of detractors.
David Swensen, the long-time manager of Yale University’s endowment, recently slammed FOFs, claiming among other things, they “are a cancer on the institutional investor world”.
Although Mr Swensen has a well-renowned track record, his group isn't the only one to have added value over the past couple of decades. In fact, as a substitute for equity investments over the past 10 years, the Hedge Fund Research (HFR) FOF Index has performed remarkably well, returning 5.4% a year versus a return of minus 1.4% for the S&P 500, with a volatility of 6.2% versus 15.1% for large cap equities.
Nevertheless, the very public failures have stuck a knife in FOFs. According to a recent report by HFR, FOFs are liquidating much faster than they're being created.
Hedge fund liquidations rose in the first quarter of 2010 with 240 funds closing during the period, according to the HFR Market Microstructure Industry Report recently released. Liquidations were disproportionately skewed towards FOFs, with 102 closing in the quarter. This marks the 7th consecutive quarter in which FOF liquidations have exceeded new launches.
Fee pressure is finally making itself present in the industry. Average incentive fees declined by 8 basis points to 19.12% in the 1st quarter of 2010, the steepest drop since the 2nd quarter of 2008, although average management fees were unchanged at 1.58%. Variance between the best and worst deciles of performance narrowed in the less volatile period, with the top decile of all hedge funds returning an average of 15.2%, while the bottom decile lost an average of 8.6%.
“Both investors and fund managers are continuing to exhibit a heightened sensitivity to leverage and risk, even with the benefit of the performance recovery from 2009,” said Ken Heinz, President of HFR. “Managers are employing lower levels of leverage in response to higher realized asset volatility and higher costs of obtaining leverage, as well as investor preference for a less volatile return profile.”
Caveat emptor. What this all should tell you is that if the people who spend every day talking to hedge funds, analysing their returns and statistically measuring how much value they add can be fooled, so can you. Another reason to avoid this entire industry.
Marko's Take
Showing posts with label hedge funds. Show all posts
Showing posts with label hedge funds. Show all posts
Thursday, June 24, 2010
Thursday, June 10, 2010
Hedge Funds Fail To Prevent Large Losses In May
While many, if not most, hedge funds don't actually "hedge", they do promote themselves as un-correlated to the market, thereby theoretically providing investors with less risk. Unfortunately, their performance during market meltdowns demonstrates quite the opposite.
Nearly every market correction or bear market has been accompanied by overall poor returns and often complete wipe-outs of these believed-to-be elite vehicles. Is this asking too much? Possibly, but since most funds charge premium fees, shouldn't investors expect premium performance? Especially during the most volatile and difficult periods?
The month of May, which included a 1,000 point intra-day loss for the Dow Jones Industrial Average, was a perfect test case. Volatility, which had been subdued for a year, suddenly exploded. If there was any time for a hedge fund to strut its stuff, it was last month. How'd they do?
Terribly! May was the worst month for hedge funds since November 2008, according to Hedge Fund Research Inc. (HFR). Virtually every strategy was down. Larger funds managed by SAC Capital, Paulson & Co. and Third Point Management lost between 2.3% and 5.6% in the month, say people familiar with the funds. Their mistakes ranged from concentrated bets on consumer companies to financial-company wagers.
Louis Bacon, who founded Moore Global Investment, had scored annual gains of about 20% on average over the past two decades. His largest fund endured losses of 9.2% in May, way underperforming the average decline of 2.3%, according to HFR's index.
The average hedge fund was up 1.3% for 2010 through May, compared with a 6.4% decline for the big Moore fund.
Eurekahedge, a Singapore-based fund tracker, publishes a series of indices on a monthly basis, measuring the returns of hedge funds by region and investment strategy. Its indices showed hedge funds focusing on Asia (excluding Japan) lost an average of 4.86% during the month of May, pushing total returns for 2010 to minus 3.15%.
Barclay's index of hedge fund returns for May, which encompasses more than 1,300 funds, showed a loss of nearly 3%, nearly wiping out all returns for 2010. The Credit Suisse/Tremont Index revealed a drop of 2.26%.
But money still poured into hedge funds for a second consecutive quarter, making the industry reach $1.66 trillion of assets under management, up from $1.60 trillion in the last quarter of last year, HFR reported. The hedge fund industry reached a record $1.8 trillion under management at the peak of the market in 2007, but the figure is now lower following client withdrawals and the credit and equity losses suffered during the credit crunch.
While hedge funds advertise themselves as sophisticated investors, they are still prone to huge losses which can easily become complete wipe-outs. This is the result of the use of massive leverage in combination with risky trades. Since they make their compensation by taking a portion of gains, but don't always cough up money when they lose, hedge funds are incentivized to roll the dice. Heads I win, tails you lose.
Everyone who still has assets in my fund, please step forward. You, not so fast!
Of course, if they screw up, they are the first to accept responsibility (sarcasm intentional). Goldman Sachs (GS) was sued for $1 billion by Basis Yield Alpha Fund (Master), an Australian hedge fund, claiming that the bank made “misleading statements” in connection with Timberwolf, a complicated mortgage security the bank underwrote in 2007.
A spokesman for GS said: “The lawsuit is a misguided attempt by Basis, a hedge fund that was one of the world’s most experienced CDO investors, to shift its investment losses to Goldman Sachs." Loathe as I am to agree with "Government Sachs", they have a point. How does an entity claiming expertise in CDO's get taken advantage of to the tune of a total loss? Goldman did NOT force them to over-leverage.
A spokesman for GS went further: “At the time of the Timberwolf transaction, Basis specifically stated that it would not place any reliance on Goldman Sachs. Basis is now trying to recoup its losses based on false allegations that it was misled about aspects of the transaction and market conditions.”
Sorry Basis, you can't have it both ways. You either know what you're doing, or you don't. You can't claim to be an expert, sign a "big boy" letter attesting to that and then claim to have been duped.
Of course, if the trade had worked out for you, and GS lost money, you'd have no problem with the "misleading statements". Or, would you give it back to Goldman? Point made.
If you're invested in hedge funds, caveat emptor.
Marko's Take
Please visit some of our favorite places for lots of great information to investors at a very reasonable price. We particularly like the following: http://www.lemetropolecafe.com/, http://www.aegeancapital.com/, http://marketviews.tv/, and, of course, our own You Tube channel at http://www.youtube.com/markostaketv.
Nearly every market correction or bear market has been accompanied by overall poor returns and often complete wipe-outs of these believed-to-be elite vehicles. Is this asking too much? Possibly, but since most funds charge premium fees, shouldn't investors expect premium performance? Especially during the most volatile and difficult periods?
The month of May, which included a 1,000 point intra-day loss for the Dow Jones Industrial Average, was a perfect test case. Volatility, which had been subdued for a year, suddenly exploded. If there was any time for a hedge fund to strut its stuff, it was last month. How'd they do?
Terribly! May was the worst month for hedge funds since November 2008, according to Hedge Fund Research Inc. (HFR). Virtually every strategy was down. Larger funds managed by SAC Capital, Paulson & Co. and Third Point Management lost between 2.3% and 5.6% in the month, say people familiar with the funds. Their mistakes ranged from concentrated bets on consumer companies to financial-company wagers.
Louis Bacon, who founded Moore Global Investment, had scored annual gains of about 20% on average over the past two decades. His largest fund endured losses of 9.2% in May, way underperforming the average decline of 2.3%, according to HFR's index.
The average hedge fund was up 1.3% for 2010 through May, compared with a 6.4% decline for the big Moore fund.
Eurekahedge, a Singapore-based fund tracker, publishes a series of indices on a monthly basis, measuring the returns of hedge funds by region and investment strategy. Its indices showed hedge funds focusing on Asia (excluding Japan) lost an average of 4.86% during the month of May, pushing total returns for 2010 to minus 3.15%.
Barclay's index of hedge fund returns for May, which encompasses more than 1,300 funds, showed a loss of nearly 3%, nearly wiping out all returns for 2010. The Credit Suisse/Tremont Index revealed a drop of 2.26%.
But money still poured into hedge funds for a second consecutive quarter, making the industry reach $1.66 trillion of assets under management, up from $1.60 trillion in the last quarter of last year, HFR reported. The hedge fund industry reached a record $1.8 trillion under management at the peak of the market in 2007, but the figure is now lower following client withdrawals and the credit and equity losses suffered during the credit crunch.
While hedge funds advertise themselves as sophisticated investors, they are still prone to huge losses which can easily become complete wipe-outs. This is the result of the use of massive leverage in combination with risky trades. Since they make their compensation by taking a portion of gains, but don't always cough up money when they lose, hedge funds are incentivized to roll the dice. Heads I win, tails you lose.
Everyone who still has assets in my fund, please step forward. You, not so fast!
Of course, if they screw up, they are the first to accept responsibility (sarcasm intentional). Goldman Sachs (GS) was sued for $1 billion by Basis Yield Alpha Fund (Master), an Australian hedge fund, claiming that the bank made “misleading statements” in connection with Timberwolf, a complicated mortgage security the bank underwrote in 2007.
A spokesman for GS said: “The lawsuit is a misguided attempt by Basis, a hedge fund that was one of the world’s most experienced CDO investors, to shift its investment losses to Goldman Sachs." Loathe as I am to agree with "Government Sachs", they have a point. How does an entity claiming expertise in CDO's get taken advantage of to the tune of a total loss? Goldman did NOT force them to over-leverage.
A spokesman for GS went further: “At the time of the Timberwolf transaction, Basis specifically stated that it would not place any reliance on Goldman Sachs. Basis is now trying to recoup its losses based on false allegations that it was misled about aspects of the transaction and market conditions.”
Sorry Basis, you can't have it both ways. You either know what you're doing, or you don't. You can't claim to be an expert, sign a "big boy" letter attesting to that and then claim to have been duped.
Of course, if the trade had worked out for you, and GS lost money, you'd have no problem with the "misleading statements". Or, would you give it back to Goldman? Point made.
If you're invested in hedge funds, caveat emptor.
Marko's Take
Please visit some of our favorite places for lots of great information to investors at a very reasonable price. We particularly like the following: http://www.lemetropolecafe.com/, http://www.aegeancapital.com/, http://marketviews.tv/, and, of course, our own You Tube channel at http://www.youtube.com/markostaketv.
Monday, January 4, 2010
What Exactly Is A Hedge Fund?
A pretty damn good way to either make or lose a lot of money! Hedge funds are a form of pooled capital, such as a mutual fund. However, compensation structures are vastly different!
Mutual funds typically charge a fixed management fee - usually in the range of .50% to 1% of assets annually. They also carry administrative fees which are normally very near .25% per year. Some have fees for their sales, called "loads". These fees can be quite expensive - as much as 5% up front! But, loaded funds are relatively few. I advise that you NEVER buy a loaded fund!
Hedge funds are all about compensation! I should know. I ran a series of hedge funds for years. Typically, the management fee runs 2% per year in addition to some sort of reimbursement for expenses, which is highly variable, but not usually less than 1% annually. The way that hedge funds produce exorbitant riches for their sponsors is through a "performance fee" assessed by scooping a portion of the fund's profits. Performance fees are typically 20% of the fund's profit minus a benchmark such as the T-Bill rate.
One problem with hedge funds is, that while they charge you for winning, they don't "eat it" for losing! Unless they contain a provision known as a "highwater mark". That feature allows investors to recapture losses, but only after profits have been made. For example, if a fund's performance fee is $1 million, it will discontinue earning addition performance fees until the highwater mark of $1 million has been exceeded. In NO circumstances, that I'm aware of, do hedge funds ever return MORE than the highwater mark. Said differently, performance fees can NEVER drop below zero on a cumulative basis.
Because of the nature of performance fees, hedge funds are highly incentivized to take excessive risk. "Heads I win... Tails I win!
I've never heard of a mutual fund going belly up, yet, hedge funds are famous for a variety of scandals, sometimes resulting in a complete and total loss to investors. The most recent and notorious example is the Bernie Madoff caper. But, there have been many, many others!
Finally, the term "hedge fund" is a misnomer as many, if not most funds, do no hedging at all! A "hedge" involves taking some sort of position designed to partially offset another position. For example, a hedge might consist of buying certain stocks, while simultaneously offsetting the risk via the short sale of other stocks, but not the same stocks.
Tomorrow, we'll put a "shine" on the Gold and Silver Market.
Marko's Take
Mutual funds typically charge a fixed management fee - usually in the range of .50% to 1% of assets annually. They also carry administrative fees which are normally very near .25% per year. Some have fees for their sales, called "loads". These fees can be quite expensive - as much as 5% up front! But, loaded funds are relatively few. I advise that you NEVER buy a loaded fund!
Hedge funds are all about compensation! I should know. I ran a series of hedge funds for years. Typically, the management fee runs 2% per year in addition to some sort of reimbursement for expenses, which is highly variable, but not usually less than 1% annually. The way that hedge funds produce exorbitant riches for their sponsors is through a "performance fee" assessed by scooping a portion of the fund's profits. Performance fees are typically 20% of the fund's profit minus a benchmark such as the T-Bill rate.
One problem with hedge funds is, that while they charge you for winning, they don't "eat it" for losing! Unless they contain a provision known as a "highwater mark". That feature allows investors to recapture losses, but only after profits have been made. For example, if a fund's performance fee is $1 million, it will discontinue earning addition performance fees until the highwater mark of $1 million has been exceeded. In NO circumstances, that I'm aware of, do hedge funds ever return MORE than the highwater mark. Said differently, performance fees can NEVER drop below zero on a cumulative basis.
Because of the nature of performance fees, hedge funds are highly incentivized to take excessive risk. "Heads I win... Tails I win!
I've never heard of a mutual fund going belly up, yet, hedge funds are famous for a variety of scandals, sometimes resulting in a complete and total loss to investors. The most recent and notorious example is the Bernie Madoff caper. But, there have been many, many others!
Finally, the term "hedge fund" is a misnomer as many, if not most funds, do no hedging at all! A "hedge" involves taking some sort of position designed to partially offset another position. For example, a hedge might consist of buying certain stocks, while simultaneously offsetting the risk via the short sale of other stocks, but not the same stocks.
Tomorrow, we'll put a "shine" on the Gold and Silver Market.
Marko's Take
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