It started with CALPERS, then a year and a half later came NYCERS, weeks after it was Buffett’s turn, climaxing 48 hours hence with Stevie Cohen (of all people!).1 As the crescendo of hedge fund bashing reaches it’s peak, I’ll seize the moment to make three observations that differ from everyone else who’s piling on the financial topic du jour.
Before I do, let me say that I’m in no way a cynic of the criticisms that are currently being leveled at hedge funds overall. Extremely high fees combined with a very crowded arena have more than eliminated any possibility of taking advantage of inefficiencies.2 Nevertheless, this was also the case 3, 6, and even 9 years ago3 to anyone immersed in Wall Street who made an objective back-of-the-envelope analysis (Warren Buffett wasn’t the only one). Yet institutional investors, who’s objectivity may very well have been hindered by the extreme shortfalls in their projected pension funding, continued to pile into “alternatives” from what in many cases was a very small or non-existent base.
With that as a background, my first thought in reading the excoriating hedge fund headlines and quotes, is that after the effects of this verbiage leads to the inevitable exodus from hedge funds – in about 6-9 months4 – markets themselves will have reached a crescendo, and fall. Wait, make that crash! Of course they will, this always happens immediately following the removal of all hedges, doesn’t it? In all seriousness, equity markets are currently at all-time highs, and bond yields are anemic. As monies get taken out of hedge funds and redeployed into long-only markets, pension fund investors will inevitably have zigged, when they should have zagged. They always seem to feel the need to “put-it-to-work”, and can’t -or don’t have the luxury to just let it lay fallow like Warren.
Of course they can, and probably will, reallocate some of this money into Private Equity (PE), in the hopes of garnering expected returns not tethered too closely to zero. Thus my second thought in reading the hedge fund bashing headlines is “Isn’t Private Equity also due for similar scrutiny?” So far investment in it has completely escaped opprobrium and continues to see big inflows. In fact, just today – in the midst of all this HF bashing, comes an article saying the PE firms are regaining the upper hand on institutional investors. Taking fees to all time highs and “eliminating terms from their current funds that are designed to protect limited partners, such as preferred returns, also called hurdle rates, and clawbacks.”
Personally, I think the lack of criticism towards PE has to do with the difficulty attaining real annual performance numbers5 and zero accounting for volatility; the lack of a suitable, or any, benchmark; and the opacity of their fees. I have a lot more skepticism about investing in PE in the 21st century, but lack the time to script all my thoughts at this moment6, and don’t want to get too off topic. Underlying this skepticism is many of the same critiques leveled at hedge funds, including crowding – whether one calls them trades or acquisitions, and Warren’s lament about “Wall Street salesmanship” trumping performance.
Finally, the third and most important thought I have in reading the latest financial brouhaha, is that both institutional managers and Warren Buffett are ignoring the biggest curse facing investors today: the tremendous skimming of profits by the executives of corporate America. Somewhere between 25% and 45% of reported earnings in the S&P 500 are fictitious and not going into the coffers of the owners – aka CALPERS, NYCERS, their beneficiaries, and anyone else with a pension plan, 401K, IRA, or personal savings invested in the stock market.
This is the current financial debacle unfolding – and not being publicized. It doesn’t evince itself in the same manner as comparing a hedge fund index to another benchmark. Nevertheless, too many top executives are getting superstar pay for blocking and tackling, and in aggregate there is no value added in having CEO X (& team) vs. CEO Y. Thus, I’ll finish by paraphrasing Buffett this weekend, and state that net of all real fees (aka true compensation), as a group the CEO’s of publicly traded corporations underperform what you could get “sitting on your rear end.”
The Skim and the Partial Ponzi: https://theshadowbanker.org/2016/02/29/partial-ponzi-skim/
- This hf manager rarely, if ever, talks about the markets or to the press/public directly, and most news about him focuses on his art collection, home sales, personal wealth, and travails w/ the SEC. Though long before he was famous, he did go on the Dating Game! [↩]
- Ironically, Steve Cohen’s comments this week lamented the lack of talent in the hf industry today. Personally I think it’s the exact opposite. Largely due to his and others tremendous growth and financial success managing hedge funds, they have spawned a whole slew of Stevie Cohens. Thus it’s a v crowded market and there is way too much brain power analyzing securities in 2016 [↩]
- Huge tip of the hat to Buffett, who not only saw this but put money and his reputation on it in his $1 million bet w/ Ted Seides of Protege Partners [↩]
- institutional investors are slow to act [↩]
- instead of mark to market like in the hf world, it’s mark to whatever the PE manager thinks a company’s value is [↩]
- though I will someday soon, so stay tuned [↩]