Friday, May 30, 2014

Stock Market: The Real Hedge Funds Scandal

(Drivebycuriosity) - Do you want to be mega-rich - part of the one percent? Then you should start a hedge fund. Hedge fund managers earn outrageous incomes - the top stars cash each more than $2 billion per year (newyorker). Hedge funds "get paid whether the market goes up or down", reports "Bloomberg" (bloomberg) and they "seem to have the ability to charge whatever they want", writes "Institutional Investor" (institutional).

Do their customers, those who invest into hedge funds, earn stellar results? Nope. "Over the past 10 years, even a conservative portfolio that invested just 60% in the US stock market (S&P 500) and kept 40% in bonds still outperformed the average hedge fund", discloses "MarketWatch" (marketwatch). So, even Joe Sixpack who puts some money into S&P 500 ETFs can do better.

"Why do they make so much?" asks "The New Yorker" (newyorker) and adds: "It’s a competitive industry, and there’s no obvious reason why the normal laws of economics shouldn’t apply," meaning that their fees should follow their meager results.

The "New Yorker" and other commentators explain the extreme high fees partly with the fact that hedge funds don`t cater Joe Sixpack. By law only certain types of investors are allowed to put their money into a hedge fund -- very rich people (the one percent) and large institutional investors, such as pension funds, charitable endowments, and even government investment funds.

I don`t care what billionaires do with their own money, but it is a real scandal that pension funds and charitable endowments, thus institutions which administer the money of other people, spend billions of dollars for hedge funds fees. Why do these institutional investors burn tons of other peoples money, for instance the pensions of their clients, for an industry which performs on average worse than Joe Sixpack? Why does for instance California´s "CalPERS", a huge public employees' retirement system, pay more than $1 billion fees for "external management fees" (twitter). This money is of course not any more available for the pensions of their clients.

"Institutional Investor" author Ashby Monk (institutionalinvestor) complains that pension fund managers, the largest group of hedge fund investors, are too generous with other people`s money (economists know this as the principal-agent-problem). Monk calls this problem a "governance deficiency", in plain English, these pension funds and other public institutions are bad managed and their manager don´t do the best for their clients, the people who`s money they administer. The boards of the pension funds, those who control these huge institutions, "need to recognize that paying $1 billion in external fees per year is completely outrageous. But many don`t", critizes Monk.

Why do billionaires and public servants waste their own and other peoples money to finance a crowd of hedge fund billionaires? The answer is - I believe -  the huge reputation of hedge funds. Many people, including billionaires and curators of pension funds, seem to believe that hedge fund managers are gods and can walk over water.  Tadas Viskanta, owner of the blog "Abnormal Returns" reports, that at the Skybridge Alternatives Conference - a gathering of hedge fund managers and their groupies -, "host Anthony Scaramucci told attendees that “Mutual funds are the propeller planes…while hedge funds are the fighter jets.”(money).

Blind Trust

And in indeed, hedge funds are hyped in the media and treated like rock stars. Journalists are gluing at their lips and are quoting any comment of a hedge fund manager as it would be the epiphany of a messiah. Hedge funds are usually called "smart money" , even that they on average perform worse than Joe Sixpack and usually sell when everybody is selling and buy back when everybody is buying (herding behavior).

This cult around hedge funds reminds me of the Bernard Madoff investment scandal (wikipedia). The Wall Street rogue financier offered modest but steady returns to an exclusive clientele, reports Wikipedia. The fraudster claimed that he - with the use of futures and options - could cushion the returns of the invested money against the market's ups and downs, exactly what hedge funds also claim. Madoff`s clients included banks, hedge funds, charities, universities, and wealthy individuals, including Steven Spielberg, actors Kevin Bacon, Kyra Sedgwick, John Malkovich, and Zsa Zsa Gabor.

Madoff`s customers became victim of their blind trust in celebrities.  Anyway, what these super rich people did with there own money is not my business. But it is a scandal that institutional investors like banks, charities and universities handed the money of their clients over to someone they don´t control. Hedge funds may be legal (even that some managers got caught with insider trading), but when administrators of public funds pay hedge funds billions of dollars fees out of the pockets of their customers - this is another scandal!

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