Are Hedge Funds Too Big To Beat The S&P?

When I started my hedge fund career in 1998, the industry controlled about $200 billion in assets in 3,000 funds. Today, according to BarclayHedge numbers, there are between 10,000 and 15,000 funds investing over $3 trillion. But we seem to have lost a little something along the glorious speedway of growth. Performance, to be precise. As I looked back at the coming of age of hedge funds in the last twenty-something years, I couldn’t help but wonder: when it comes to performance, does size matter?

Not to be fastidiously historical, but from 1998 to 2008, hedge funds beat the S&P in seven out of eleven years, according to the Callan Institute periodic return tables. After 2008, they beat the index…once: in 2018, by 1.1%. Yes, for ten out of the last eleven years, the S&P has outperformed hedge funds, not by a little, but by a whopping 9.4%. I suspect that the poor showing of the hedge fund index is even understated, because it likely has a survival bias − meaning that the worst performing hedge funds go out of business and are not counted in ensuing years.

Why the consistently lackluster returns? My experience as a twenty-year investor in the high yield and distressed markets is that it is hard enough to have ten great ideas to invest $1 billion. When you invest $10 billion and you need a hundred great investments – unique and executable − it’s mission impossible. Call me a fatalist, but invariably the top ten are great, the next ten conceivably good, and so on…until the bottom of the barrel is simply lame. Why not invest more money in the top ten ideas? Because of size limitations: ten distressed situations large enough to invest $1 billion do not systematically exist, at least not without considerably moving the price.

Admittedly, distressed investing, a sub segment of the alternative investment landscape, is a niche market that simply may not accommodate the current size of hedge fund assets. And mine may only be an anecdotal experience. But the same opinion has been publicly voiced by several legendary investors in different markets.

In 2016, speaking at the Milken Investment conference, Steve Cohen of Point72 declared that there were “too many players out there trying to do similar strategies”. Dan Loeb wrote in his investment letter the same year that we were “in the first innings of a washout in hedge funds and certain strategies.” Since then, the industry has added almost $1 billion in assets. A superior intuition tells me, however, that both investors referred to the demise and shortcomings of others – their own fund would continue to grow and thrive. Recommended For You

But what if you could extrapolate the question to the entire hedge fund industry, as one asset class, in an analytical rather than subjective manner?

I came upon a fascinating study by Marco Avellaneda, director of the Division of Financial Mathematics at the Courant Institute of New York University, who presciently asked, back in 2005: “Hedge funds: how big is big?” The first concept he introduces is that of capacity: the total amount of money that can be put to work with a given manager or strategy without negatively affecting performance. He corroborates my experience that some strategies (currency trading for example) have greater capacity than others (distressed investing in my example), and consequently that investors, all things equal, should prefer deep capacity rather than niche strategies.

The problem then becomes, can hedge funds deliver outsized risk-adjusted returns in markets that are highly liquid and efficient? His answer is that they can, to the extent that they offer superior investment skills. And since above-average skills are, by definition, in limited supply, as money (i.e. demand for skills) pours into the hedge fund industry, it begins funding managers whose skills “are not superior to those that are needed for index investing”. Here, academia poetically meets practitioners. Mr. Cohen succinctly remarked in the same panel that “talent is very thin” and eloquently added that he was “blown away by the lack of talent.”

And so, comes the point at which hedge funds are too large to beat the market: they are the market. Professor Avellaneda uses a linear regression to study the marginal return of a dollar invested at any given hedge fund size. As expected, the line is well-fitted and downward sloping, meaning that returns diminish as assets increase. He insightfully extrapolates that the hedge fund industry will no longer outperform the S&P 500 past $2 trillion in size.

The industry first reached $2.3 trillion in 2008 (dipping for two years after the Global Financial Crisis before ramping back up to today’s $3 trillion): precisely the year that started the streak of a ten out of eleven-year underperformance. Naturally, one can wish to invest in hedge funds for diversification. But it will take innovations and changes for a trend reversal in outperformance. Follow me on LinkedIn. Check out my website.

Dominique Mielle

 Dominique Mielle

I spent twenty years as a partner and senior portfolio manager at Canyon Capital, a $25 billion hedge fund. In 2017, I was named one of the “Top 50 Women in Hedge Funds” by Ernst & Young. 

One of the only senior women in the hedge fund business, I played key roles in complicated bankruptcies, serving as a leading creditors’ committee member for Puerto Rico, and as a restructuring committee member for U.S. airlines in the wake of the September 11 attacks. 

I was a director and the audit committee chair for PG&E during its fifteen-month bankruptcy process and emergence, and now sit on the board of Digicel, Anworth (ANH), Studio City (MSC) and Tiptree (TPTR). 

Since retiring in 2018, I have been working on a book about being a female investor in the golden age of hedge funds. For more information visit http://www.dominiquemielle.com

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Warren Buffett made a $1 million bet in 2007: that hedge funds would not outperform index funds over the next 10 years. WSJ’s Nicole Friedman checks the numbers and handicaps Buffett’s chances of winning the bet on Lunch Break with Tanya Rivero. Photo: Bloomberg Subscribe to the WSJ channel here: http://bit.ly/14Q81Xy More from the Wall Street Journal: Visit WSJ.com: http://www.wsj.com Follow WSJ on Facebook: http://www.facebook.com/wsjvideo Follow WSJ on Google+: https://plus.google.com/+wsj/posts Follow WSJ on Twitter: https://twitter.com/WSJvideo Follow WSJ on Instagram: http://instagram.com/wsj Follow WSJ on Pinterest: http://www.pinterest.com/wsj/ Don’t miss a WSJ video, subscribe here: http://bit.ly/14Q81Xy More from the Wall Street Journal: Visit WSJ.com: http://www.wsj.com Visit the WSJ Video Center: https://wsj.com/video On Facebook: https://www.facebook.com/pg/wsj/videos/ On Twitter: https://twitter.com/WSJ On Snapchat: https://on.wsj.com/2ratjSM

The Funds With The Smartest Investors, And The Funds With The Dumbest

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Are mutual fund investors impulsive? Do they jump into a fund after a winning streak and then sell out, in despair, after a bad stretch?

I tested this hypothesis by going to Morningstar MORN , the securities analysis outfit in Chicago. The Morningstar Direct database, the version of its service sold to investment pros, has performance details that shed light on timing decisions by fund buyers.

The answer to the question: Yes, fund clients are impulsive. Bad timing causes them to earn considerably less than they would have earned by buying and holding. On funds of domestic stocks, they’re throwing away something like $54 billion a year.

The key to this analysis is a number that Morningstar calls “investor return.” It measures the average results taken home, as opposed to the performance of the fund.

The usual performance number reported for a fund assumes a hypothetical buyer putting a single sum of money in at the beginning and leaving it untouched until the end of some measurement period, like a decade. Example: The Schwab 1000 Index fund delivered a 233% cumulative performance over the ten years to May 31. That amounts to a compound annual 12.8%.

The investor return on this index fund is a bit less, at 12.6%. This figure takes into account the monthly flows of money into and out of the fund. More precisely: If fund shareholders had been earning a constant 12.6% on every dollar they kept in play, they would have wound up with the fund’s ending assets. In short, the 12.6% measures average investor experience.

Where does the 0.2% shortfall come from? It means that buyers of this fund had a slight tendency to add money, or to take it off the table, at the wrong times. We’re human. After a bullish run we’re in love with stocks and buy more—maybe near a top. A correction in stocks makes bonds more appealing and we hold back, just when stocks are a bargain.

The mistakes among Schwab’s clientele pale in comparison to those of fund buyers generally. Morningstar has 827 domestic-stock funds with both ten years of history and sufficient detail on asset balances to permit a calculation of investor return. At 527 of those funds, not quite two-thirds of them, timing decisions lowered the annualized gains experienced.

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Among all 827 funds the average impact, with both positive and negative impacts included, was a loss of 0.64% a year. Keep that up for 30 years and you shortchange a $1 million retirement portfolio by $175,000.

It is important to understand what Morningstar is measuring. A shortfall does not occur when a customer is invested for only a portion of the ten-year period, since both the reported performance figure and the investor return are compound annual percentages. (Morningstar’s investor number is an internal rate of return. For an explanation of how that arithmetic works, see this article on how to compare your results to a yardstick.)

A shortfall will show up, though, if people jump into a style or sector after an upswing, only to be disappointed and then move into another kind of fund that seems to be the new ticket to wealth. Such performance chasing depresses investor returns at both funds.

Some funds have customers who are either lucky or smart. Their timing is good. They do better than the performance figures indicate.

These ten funds all beat the market, as measured by the Schwab index fund, and had customers who improved on those good results by being invested at the right times:

Noteworthy on this list are two funds from the Kayne Anderson Rudnick subsidiary of Virtus Investment Partners VRTS . KAR leans toward concentrated, quirky portfolios of stocks like Teladoc Health and Morningstar. (Forbes profile here.)

Winning funds with well-timed investor moves are the exception. More common: funds where investor flailing depresses gains. These ten underperformed the market and had customers who magnified the damage with their stumbling:

I asked the operators of the second group of funds for comments and got one, from Needham:

“Our mission is to create wealth for long-term investors. Those who trade mutual funds or try to time the market may see returns that are less than those who stay invested and have been rewarded with excellent long-term returns.”

Moral of this story on investor returns: Follow Needham’s advice. Invest with enough conviction that you can stay put.

And if your attention is fleeting? Maybe you should discontinue the search for market beaters and just own an index fund.

Here’s one more statistic from that Morningstar data set. The average investor experience in the 827 funds was a compound annual 10.5%. That’s 2.3 points less than the return on the Schwab 1000 fund. This shortfall comes from both bad timing by customers and a parallel flailing by the funds. In their struggle to beat the market the fund managers ran up trading costs as well as their own management expenses.

Yes, 2.3% is a gigantic loss. Keep it up for 30 years and you cut your $1 million retirement in half.

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I aim to help you save on taxes and money management costs. I graduated from Harvard in 1973, have been a journalist for 45 years, and was editor of Forbes magazine from 1999 to 2010. Tax law is a frequent subject in my articles. I have been an Enrolled Agent since 1979. Email me at williambaldwinfinance — at — gmail — dot — com.

Source: https://www.forbes.com

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Many investors have bad habits that keep them from becoming as wealthy as they could be. A lot of times, people aren’t even aware of their own bad habits. If you want to be the best investor you can be then watch out for these investing mistakes. http://bit.ly/2IWg0jE

3 Ways to Recession-Proof Your Company & Why Right Now Is the Best Time to Do It

David Barrett survived the Great Recession by making his business as boring as possible.In 2007, the founder and CEO of Expensify was trying to launch a prepaid debit card that would enable–and hopefully encourage–charitable giving to panhandlers in San Francisco. But, as forecasts of economic turmoil mounted, investors were interested only in ideas that sounded “sane and reasonable,” he says. So Barrett started pitching the safest related product he could imagine: an automated expense-report management system.

That worked; Barrett secured enough money to quit his full-time job in April 2008. He still intended to pursue the card idea, but soon hit a production snag–and with the economy in free fall, Barrett recalls thinking, “Shit, I really need to make a business out of this right now.” So he doubled down on business-expense management.

Almost 1.4 million small businesses with employees closed from 2008 through 2010, according to the U.S. Small Business Administration. Expensify, now with five offices and a staff of 120, wasn’t one of them–a feat Barrett attributes to those pre-recession pivots. They taught him to “build a product that is needed in a downturn,” he says. “Sell aspirin, not vitamins.”

Recession war stories may seem out of place during this prolonged period of economic growth, but there are signs that a slowdown is on the way. A June 2019 survey from the National Association for Business Economics put the risks of a recession beginning before the end of 2020 at 60 percent. A third of the 2019 Inc. 5000 CEOs expect a recession to begin this or next year, with another third bracing for one in 2021. Whenever the downturn hits, these steps can help your business weather it.

Fundraise.

Build your cash reserves while you can. Serial entrepreneur Mitch Grasso had a potential downturn in the back of his mind while raising capital for his latest venture, Beautiful.ai. The presentation software company raised $11 million in Series B funding in March 2018, just 17 months after a $5.25 million Series A round. “I chose to raise money earlier than I would have otherwise, even though it cost me probably a little more” in terms of valuation, says Grasso. “If there’s money on the table, take it sooner rather than later. You’ll always find a way to spend it.”

Conduct consumer research.

You might not be able to pivot your entire business model, so figure out what products and services your customers will need even in poor conditions, says Carlos Castelán, managing director of the Navio Group, a retail business consulting firm.

Ryan Iwamoto, co-founder of caregiving service 24 Hour Home Care, started asking his customers for their input when the federal government introduced sweeping rules for home health care agencies in 2016. He wanted to be “the first in market to educate them on all the regulations coming down in our industry,” Iwamoto says. “It allowed us to build better relationships”–and has helped boost his company’s revenue by more than 68 percent since the law changed, he reports.

Ink multiyear contracts with clients, not vendors.

Earlier this year, during a regular assessment of her company’s revenue targets, Sandi Lin considered the potential impact of an economic slowdown. The co-founder and CEO of Skilljar was happy to discover half of the customer training platform’s revenue was on multiyear contracts, meaning “at least theoretically, that even if all of our other customers went bankrupt,” Skilljar would have some runway–and less pressure to scramble for new business.

Lin applies the opposite approach for vendor contracts; while Skilljar is sponsoring a major customer conference this fall, she negotiated a minimal commitment on room nights and seats with the hotel and venue. Which is a smart business practice in good times, too; as Lin says, “the most important job of an entrepreneur is to survive.”

By: Jeanine Skowronski

Source: 3 Ways to Recession-Proof Your Company–and Why Right Now Is the Best Time to Do It

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The Greatest Fund Managers Midyear Review

An updated spreadsheet of the greatest fund managers is available to download at the link at the end of this article.

An updated spreadsheet of the greatest fund managers is available to download at the link at the end of this article.

At the midpoint of the year, it’s time to review the performance of the greatest fund managers. I have received many emails from readers asking how to use the spreadsheet listing the greatest fund managers that I make available for download. Many readers start by sorting the spreadsheet by year-to-date returns. Let me explain why that does not get you to funds I would recommend as top choices.

The top 3 funds on the spreadsheet sorted by year-to-date (YTD) return are Kinetics Internet (WWWFX) up 38.47% YTD, Virtus Zevenbergen Innovative (SAGAX) up 36.58% YTD, and Artisan Mid Cap (ARTMX) up 33.95% YTD. Here’s how I look at each of them.

Kinetics Internet

Murray Stahl has been at the helm for 18 years. For the last 10 years, he has beaten his category benchmark by 0.26% a year — including the past 6 months of stellar returns. If you invested $10,000 in this fund 10 years ago, you would have beaten the category benchmark by $263.06. Beating his benchmark for 10 years is an achievement for Stahl, but the outperformance is not enough to make a difference for investors.

Virtus Zevenbergen Innovative

Brooke de Boutray has managed this fund for 11 years. Over the last 10, she beat her category benchmark by 3.21% a year which translates to an additional $3,715.69 return on a $10,000 investment over 10 years — that’s more like it. The only problem is the fund has a hefty 5.75% load. Although the manager has proven her skill, I would prefer not to pay a load unless there was no other alternative.

Artisan Mid Cap Investor

James D. Hamel has managed the fund for 10 years, outperforming his benchmark by 1.19% a year which means Hamel added $1,255.79 over 10 years on a $10,000 investment on top of the benchmark return.

My Take: The best evidence of a manager’s skill is the margin of outperformance over a market cycle (10 years minimum). The bigger the gap between the manager’s return and the benchmark the more confident you can be of a manager’s skill.

Stahl’s outperformance of 0.26% a year, is better than about 98% of mutual fund managers, but it is not large enough to be compelling. I leave him on the spreadsheet because he may be the best one available in many 401k plans, but he would not be among my top choices.

Even when a great manager outperforms by a large margin (as Boutray did) the fund company can make it a bad choice for investors by loading up the fees. I leave Boutray’s fund on the spreadsheet, because a lot of 401k plans only offer load funds. In that case, Boutray’s fund could be your best choice, even if it would not be among my top choices.

Hamel’s Artisan Mid Cap Fund is the best of these three, but there may be others what have performed slightly less well year-to-date but with much bigger margins over their benchmark for the past 10 years. There is a trade-off to make between recent returns and long-term returns. I will do a deep dive on this next time.

Click here to download the most recent spreadsheet listing all the funds that passed muster.

To see previous articles in this series, click here.

Follow me on Twitter or LinkedIn. Check out my website.

I am the CEO and founder of Marketocracy, Inc.,and portfolio manager at Marketocracy Capital Management, LLC. My firm maintains a database of the world’s greatest

Source: The Greatest Fund Managers Midyear Review

Forbes Mutual Fund Ratings: The Honor Roll

These funds have done well over the long pull while beating peers in bear markets. We evaluated 1,261 domestic stock funds. Twenty-six were good enough to make our Honor Roll. The select list includes some familiar names, like Vanguard Primecap and Fidelity Contrafund, and some less familiar ones like Parnassus Core Equity. Honor Roll members cleared three hurdles. They had to beat the stock market over three market cycles going back to October 2002. They had to hold up comparatively well in down markets, earning an A+ or A. They had to keep their expenses to a reasonable level: below the 1.5% median for this collection of mutual funds……

Source: Forbes Mutual Fund Ratings: The Honor Roll

60% of Small Business Owners Never Apply for Funding to Support Innovation

60% of Small Business Owners Never Apply for Innovation Funding

The Creating Wealth through Business Improvements report from BMO Wealth Management reveals 60 percent of small business owners never apply for funding to support innovation.

With the development of digital technology and advances in smartphones, apps, artificial intelligence, and social media to name a few, small businesses have to support and implement the latest innovation as quickly as possible. According to the report, innovation drives financial success for businesses of any size.

This is especially true for small businesses because the right innovation allows for the creation of new products, services and marketing as well as ways to reach consumers. In addition to the improved external capabilities, it also makes internal teams more productive.

Innovation Funding is Important

Even if small business owners would like to innovate, they are often either unaware or not capable of accessing the funds they need. In a press release announcing the results, Tania Slade, National Head of Wealth Planning at BMO Wealth Management (U.S.) explained the importance of access to information for small businesses.

Slade said, “Having access to information about funding options and support networks is essential to the continued success of a small business, particularly in its early stages. Business owners who take advantage of the numerous resources at their disposal have an immediate advantage, and a far greater chance of seeing their innovation initiatives realized.” The challenge is funding, but small business loan numbers are looking much better today.

The report comes from a survey conducted with the participation of 1,021 small business owners across the US. They were asked about keys to innovation success, experiences funding their innovation through business loans and grants, and knowledge of and participation in accelerator and incubator networks.



Key Findings

As to the 60 percent of small businesses which never applied for funding, owners gave a number of explanations for never seeking the capital they needed. More than a third or 36 percent said they didn’t want to incur additional debt, while 22 percent believed they would be rejected. Another 21 percent stated the process was too complicated.

Alternative sources of funding were also explored in the survey, including government grants and incubator and accelerator networks.

When it came to government grants, 34 percent of responding small business owners said they were not aware grants were available. Of a reported 44 percent who did know, they didn’t know where to apply.

The number of small businesses who were not aware of incubator and accelerator networks was high — 63 percent. And there was also a gap in this knowledge between men and women. Specifically, 72 percent of women entrepreneurs said they weren’t aware of funding options  from incubator and accelerator networks while only 54 percent of male entrepreneurs seemed unaware.

Why is Innovation Important?

The number one reason given by small business owners for implementing innovations in their organization was to meet the needs of clients. Sixty-nine percent of respondents gave this as the reason for innovating. Meanwhile, 61 percent said innovation was important  for maintaining growth while 60 percent said it was necessary to create a better product.



The report further indicates older entrepreneurs looked to improve the client side of the business, while their younger counterparts were focused on creating better products or services.

Key to Innovation

In the survey, business owners identified four keys to innovation. Sixty-six percent of respondents indicated funding was most important, while 64 percent said it was networking. Another 61 percent said partnerships with staff were the key to successful innovation while 40 percent identified mentoring programs as most important.

So how do small business owners continue to innovate? In the report, BMO makes the following suggestions:

  • Join a local Chamber of Commerce and attend monthly events.
  • Seek counsel from local banks to get an overview of potential loan options.
  • Read small business blogs which often highlight local, state and federal funding programs.

Conclusion

In today’s highly competitive and technologically evolving economy, small business owners can’t stop innovating. As the report rightly points out, “Innovation should be a never-ending process.” And getting informed is the best way to do it.

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