Is This the End for Hedge Funds?

Many years ago I remember reading an article about the top hedge fund managers. The newspaper columnist wrote as if they had magical powers. They had the remarkable ability to take very large sums of money and turn it into even more money.

For their services, these top managers took home hundreds of millions of dollars.

That was enough for me at 12-years old. I wanted to be a hedge fund manager.

At the time I had no idea what hedge fund managers actually did. My basic understanding was that they provided a ‘hedge’ against the market. Meaning if the market turns down, the hedge fund will likely outperform.

How were hedge funds established?

The initial idea of a hedge fund was established by Alfred Winslow Jones in 1949. While working at Fortune Magazine, Jones decided to launch a fund. One that looked similar to the hedge funds of today.

He used leverage, short sold stocks (selling stocks you don’t own) and had a strategist to make macro bets.

For a while, Jones was able to beat the S&P 500 as the economy turned down. However, the idea of a hedge fund (investment partnership) didn’t become popular until Warren Buffett and George Soros set up their own.

But are hedge funds now outdated? Many managers struggle to match the market’s returns long-term, let alone beat it. They charge exorbitant fees, adding to their underperformance.

Many investors are simply fed up and taking their money elsewhere. In 2016, more than US$60 billion was taken from hedge funds and put elsewhere.

hedge funds asset flows

Source: Bloomberg

And 2017 hasn’t been much better either. As reported by The Washington Post:

The disillusionment with stock hedge funds comes as an increasing number of institutions have grown disenchanted with the industry’s returns overall, creating the worst climate for raising money since the financial crisis. Last year, investors pulled a net $US106 billion as the private partnerships trailed global stocks, according to data compiled by eVestment.

Hedge-fund assets are up just 4 per cent this year. The number of start-ups — 369 in the first nine months of the year, according to Hedge Fund Research — is the lowest since 2000, when the big internet bubble burst.

Cheap, esoteric and private investments may end up carrying the industry if recent activity is any indication: the biggest inflows this year have gone to long-biased or long-only products run by the quantitative funds, which use computers to decide what to buy and charge lower fees than most.

Hedge funds are yet to prove themselves

But hedge funds are yet to prove themselves. We’re currently (in the US at least) in the second longest bull run in history. Such conditions harm hedge fund returns, which are supposed to be a hedge against the market.

Of course, this is a poor excuse. With the amount of money hedge fund managers are paid, they should make money regardless of the background noise.

But I suspect investors who are still in hedge funds are expecting huge returns when the market and economy finally comes crashing down.

But even if hedge funds can’t perform in the long run, there will probably be plenty around. These loosely regulated investment partnerships market themselves in such a way that draws in return hungry capital.

Bitcoin is the hot investment now

Right now the hot investment trend is bitcoin and cryptocurrencies. And according to CNBC, more than 120 hedge funds have been created to solely focus on digital currencies.

When and if the bitcoin ride ends, opportunistic managers will probably jump onto the next trend. Thus their talents lie in marketing, not necessarily investment management.


Härje Ronngard,

Junior Analyst, Markets & Money

PS: Commodities prices came back in 2016 and rallied hard in 2017. Could they continue to rally heading into 2018?

Our resource analyst, Jason Stevenson thinks so. Jason is one of the sharpest minds when it comes to the resource sector. And he’s written a report about his top 10 mining stocks trading on the ASX right now.

Harje Ronngard is a Junior Analyst at Markets and Money. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. It’s not good enough to be right on average when it comes to investing. The market is volatile and it only takes one bad day to ruin your portfolio. You don’t want to end up like the six foot man that drowned in the river that was five foot deep on average. It’s why Harje is constantly reminding investors of their downside risk here at Markets and Money. He does so by simply asking just two questions.  What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Markets and Money readers. Right now Harje is focused on managing research and investments over at the Legacy Portfolio. An investment publication designed to significantly grow investor’s wealth over time with deeply undervalued businesses. Harje also contributes his insights in Total Income, headed by income specialist Matt Hibbard. Harje loves cash-rich businesses, so he feels right at home amongst Matt’s high yielding income plays.

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