Hedge funds showed their first positive performance in six months in September, but performance in the year to date was still negative at -0.6%. And of course the worst funds can lose all or nearly all of your money, as investors in Long Term Credit Management saw to their cost a few years ago. So hedge funds demonstrate again that they can lose money just like equity and bond funds.
This dark monster, at a hedge fund conference this year, was surprised at the difficulty in finding hedge fund managers who believed the hype. They didn’t try to argue that the average hedge fund investor would make money, let alone more money than fees, let alone make enough money after fees to compensate for the high risk.
Instead it was argued that a good fund of funds manager could chose the hedge funds which would out-perform, and that as there was a wide dispersal of returns, the out-performers would out-perform by much more than your typical equity or bond out-performer. Of course they didn’t mention the corollary – that if they chose under-performers you would lose much more than if you chose a typical equity or bond under-performer.
Moreover, why should anyone trust oneself, or a fund of funds manager, to chose the out-performers or to chose a fund of funds manager who will successfully make such a selection? Perhaps it can be done, but the cost of mistakes is rather high, given the wide dispersal of returns.
Now this dark monster is not proud. His beloved Bête Noire hedge fund has not exactly done well since inauguration last year. Readers will remember that the fund was based on a scientifically developed quantitative model, using a Boîte Noire process (under which such details of the model as the number of coins tossed and the preferred zodiac signs could not be revealed). Still the Beast is confident that the new improved model will perform, as soon as the rigorous Monte Carlo simulation tests have been completed in Monaco.
With indifferent performance, will hedge funds continue to see a flood of new money? The anecdotal evidence suggests yes. This monster regularly meets pension trustees excited about their diversification away from equity risk, and about their absolute return benchmarks. It will probably take a major scandal to reverse the flood, such as a large pension fund losing a big chunk of its assets in the collapse of a few hedge funds. The Beast is looking forward to drinking lots of blood.