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When Performance Doesn’t Matter

By : Ziad K Abdelnour| 26 May 2015
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One of the most amusing phrases on Wall Street is “smart money.”

This phrase is used to describe the handful of professional investors whose abilities and foresight are thought to be so acute that they spot the big moneymaking opportunities before the average Joe Pro.

The smartest of the “smart money” is thought to be hedge funds.

A look at recent performance suggests that hedge funds are indeed extremely smart money, though not in the way that most people think.

In fact on average, hedge funds are no smarter about picking stocks or other investments than anyone else. In fact, they’re decidedly, startlingly worse.

Hedge funds are in fact shutting today at a rate not seen since the financial crisis, as many managers post disappointing returns and an elite group of firms dominate money raising.

Hedge funds, on average, have returned just 2 percent in 2014, their worst performance since 2011, according to data compiled by Bloomberg. Smaller funds have struggled to grow as institutional investors flocked to the biggest players. In the first half of 2014, only 10 firms including Citadel LLC and Millennium Management LLC accounted for about a third of the $57 billion that came into the industry.

Many of the closures have been among macro funds, which have returned less than 1 percent last year, on average, according to Bloomberg data. Macro managers have complained that in an environment of low interest rates and muted swings in prices, it’s difficult to make money.

While some commodity strategies have also struggled as oil prices have tumbled, other managers have struggled to regain after years of losses.

Stock hedge funds have climbed 41 percent since the end of 2008, according to data compiled by Bloomberg versus a 153 percent rise in the Standard & Poor’s 500 index.

But hedge funds are absolutely brilliant moneymaking opportunities for those who run and work for them.

The fees on a well-run S&P 500 index fund are about 20 basis points a year.

That means that, every year, for every $1 billion a fund has under management, the fund manager makes $2 million.

The annual fees on a dime-a-dozen hedge fund, meanwhile, are “2 and 20″ — 2% of assets and 20% of any gains, regardless of whether the gains are the result of the fund manager’s activities or simply a rising market.

That means that, for every $1 billion under management, the hedge fund rakes in $20 million per year. And if the market should rise, say, 20% in a year, the fund will collect another $40 million.

Put differently, in a year in which the market goes up 20%, the manager of a $1 billion S&P 500 index fund will make $2 million. The manager of a hedge fund that performs in line with the market, meanwhile (which most haven’t in recent years), will make $60 million.

Smart money, indeed. Looks like though it’s all in the fund gathering today no matter how you perform.

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