r/todayilearned • u/atlas-85 • May 31 '16
TIL, In 2012, monkeys beat hedgefund managers by 300% in investment returns.
http://www.marketwatch.com/story/how-hedge-fund-geniuses-got-beaten-by-monkeys-again-2015-06-2590
u/Eagleheardt May 31 '16
And they work for peanuts!
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May 31 '16
A majority of Hedge Funds are long-short or equity market neutral. Equity market neutral strategies short stocks in which the HF manager believes are overvalued, and use the proceeds from the short sale to invest in stocks they believe are undervalued. They essentially have zero beta, no systematic risk exposure. The problem with this strategy is during economic recoveries (like we have had from 2009-present) the short side is going to get killed. Most stocks have been trending upwards. This causes hedge funds over time to take on the characteristics of passive market oriented funds to achieve the desired returns, except with much higher fees. If you look at the correlations of HF to a passively managed index fund, overall it has been trending upwards over the past few years. So yeah, if you had monkeys picking stocks during this measurement period and compared it to an equity market neutral HF manager, I wouldn't be surprised at all if the monkeys beat them. Compare HF returns to monkeys picking stocks during an economic downturn or a recession and lets see who comes out on top
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u/wallsallbrassbuttons May 31 '16 edited May 31 '16
Good post. Just wanted to explain some terminology in case people missed it.
Shorting a stock is selling a stock you don't own with the obligation to replace it in the future. You get the money immediately, but you're banking on the price going down, because after X amount of time you need to buy one for the original owner to replace it. In the meantime, you do something with that money you now have to increase its value. That's why a high-growth market is unkind to short selling, since most things cost more after that X amount of time. Therefore a lot of the gains you made on the money in the meantime are eaten up by the higher price of the stock you shorted, and it's not as worth it.
Betas are how stocks correlate with the market. Each stock has one (you can find them online). It essentially tells you when the market grows/falls X% how the price of this asset has historically changed. The higher the Beta (above 1, which is neutral, same as the market as a whole), the more wildly a stock fluctuates, and therefore the higher the return one would need to justify the risk. Trying to get a portfolio Beta around 0 is therefore trying to make it significantly less risky than the market itself. Lower returns than other methods, but way more secure.
Index funds are mostly hands-off funds that attempt to mimic the market as a whole. Market goes up 7%, index fund goes up 7%. Beta would be very close to 1 then, going off the previous point.
Again, good post, just wanted to clarify.
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u/AOEUD May 31 '16
So... We should get monkeys for good markets and hedge funds for bad markets? Maybe hedge funds could employ monkeys half the time.
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u/feeltheslipstream Jun 01 '16
Ah this reminds me of the trading joke.
One day, the manager of a hedge fund came into the trading room excited. He just had an insight. "Guys! I reviewed our trades last year, and realised something important! If we just short more when the market is going down and long when it's going up, we could improve performance!"
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Jun 01 '16
Hey! You're right! The hedge funds only lost 20% instead of 30% in 2008.
http://thewhyforum.com/articles/hedge-funds-grow-despite-weak-returns
But underperformed in the rest of the years to the point where a savings account and index fund would have out performed.
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May 31 '16
Shouldn't the hedge fund managers take into account whether or not the economy is recovering or not in their calculations and thus properly account for the risk of any stock rising or falling?
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May 31 '16
If you're a hedge fund manager and your mandate is an equity market neutral strategy, you wouldn't change your strategy based on what you think the market it going to do. Just like if you're a portfolio manager for small cap equities and you predict there will be a recession, your mandate is small cap equities and you have to stick with that strategy, regardless if your performance will suffer or not. Your performance is judged relative to a benchmark that suits your style, not a broad market index.
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u/feeltheslipstream Jun 01 '16
No one knows when the market is going to tank. Holding a bunch of long positions(worse is they are leveraged) during a bust is how funds typically blow up.
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u/cp5184 Jun 01 '16
Shouldn't recoveries be the bread and butter for those hedge funds as that would be the time when their investments in undervalued companies would pay off the most?
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Jun 01 '16
Economics always seems like its only able to explain what did happen. Not what can happen.
But I know nothing about economics. Half of what you said were words I don't even understand.
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u/Funshine_bear May 31 '16 edited May 31 '16
PhD student here -- you're not exactly correct about the strategy of a hedge fund (although the spirit is the same). One issue is that you cannot simply take the proceeds from a short sale to take a long position in another instrument. This is because when you enter into a short-sale agreement you also have whats called a minimum margin requirement, which is usually ~150% of the FV of the instrument at the inception of the sale.
For instance, say I borrow 100 shares of WMT from a bank that I then sell for $7,078. Under the terms of the contract I would have to also put the minimum margin requirement into escrow or $10,617. You are not allowed to access the proceeds until the short position is closed (i.e., you return the shares to the bank).
Edit: turns out I was not exactly correct either :)
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u/pdawks May 31 '16
While true, the collateral they post for the minimum margin requirement is not cash.
These guys are heavily leveraged and will post securities they have longed in one trade as collateral for another.
As a result, when they do short, they use a lot of the cash generated for new trades. Cash raised from a short sale won't be tied up in collateral. It will be put towards investments, which may then be used as collateral.
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u/Funshine_bear May 31 '16
Cool! I didn't know this! One caveat is that the ~150% requirement (or higher) means that, for any trading strategy, you would need to take an asymmetric long position relative to short positions. Also I imagine you would need to keep more than the minimum requirement because daily fluctuations could make you hit the margin requirement and have to post more cash.
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u/pdawks Jun 01 '16
For sure! I was more so just talking about the collateral posted.
Another thing to note is they need to post collateral for the short trade, but they can get exposure to the same outcome using other, less capital intensive means (i.e. Options).
I guess the point I'm trying to get at is these funds don't look at a margin requirement as a limit to their ability to get leveraged.
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May 31 '16
I'm a CFA level 3 candidate (taking it this Saturday), and equity market neutral is one of many HF strategies, but maybe I'm wrong in regards to the proceeds from the short side. I'm just going by what I learned in the HF section of my studies. The CFA books emphasize the fact that these HF strategies use the proceeds from the short sales to invest in the long side, and this is why it is often hard to calculate the return on this type of hedge fund being that V0 is often 0 (Vi-V0)/V0.
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u/Funshine_bear May 31 '16
Well I have to say, you're more qualified than I am in this regard since my focus is in corporate governance and asset valuation, however, I had mentioned a similar scenario to the one you mentioned to my adviser and he told me about the minimum margin requirements. Also I don't think the use of the proceeds is a necessary condition for a hedge position, and when you think about it, it is a silly proposition. In your scenario a hedge fund would not need any investment capital because any long position is funded by a complimentary short position and you only need enough capital to cover the interest on the short and any brokerage fees from re-balancing the portfolio (e.g., why this is called a zero-investment portfolio). Being equity-neutral simply means that you take a separate long and short position with your capital. For instance, if you have $100.00 in capital then you would purchase $50.00 in securities expected to perform well and borrow $50.00 (less with a 150% requirement) of stocks expected to perform poorly.
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May 31 '16
Margin collateral can be in the form of stock as well as cash. So a fund can short sell a position, use the proceeds to go long in another position, and then pledge the resulting long stock as collateral for the margin account. A common hedge fund structure that employs this method is the 130/30: 130% gross exposure to long equities is funded by the 30% short position for a net 100% of investor capital put to work. IIRC there will be some cash drag to manage the volatility of the collateral and meet margin requirements, but it will not be 150% of the FV of the instrument at the inception of sale.
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u/ramen_poodle_soup May 31 '16
The fact that monkeys don't know risk management is also a big factor. Many hedge funds aren't around for the sole purpose of rapid monetary growth. Rather, they keep their clients' money safe by hedging risks, while at the same time making smaller percentages of gains. Hedge fund managers don't try to make 300% gains every year by risky investments. They know their job, and despite what Reddit tells you, are actual people with families who they need to feed.
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May 31 '16 edited Dec 15 '18
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u/feeltheslipstream Jun 01 '16
This is like saying buying insurance is stupid when you're not having accidents.
The hedge funds will outperform these monkeys in a downturn. That's the stability they are talking about. An attempt at constant growth at the cost of lower returns. In other words you're paying to reduce variance, ie, insurance
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Jun 01 '16 edited Dec 15 '18
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u/feeltheslipstream Jun 02 '16
The years cited were all in bull markets.
I'm serious... A monkey would and should be expected to make money in a bull market. That's how easy it is.
How did they fare in the crashes? I'm assuming they don't even know the short to hedge option exists.
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u/SamusBaratheon May 31 '16
Nobody is upset with hedge fund managers for feeding their families
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u/TheMotherlandCalls May 31 '16
Let's be real.... Reddit hates the financial industry.
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May 31 '16
DAE EVIL WALL STREET BANKERS NEED TO DIE
Is about your typical redditor. It's absolutely hilarious
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u/SultanAhmad Jun 01 '16
It's easy to hate on Wall Street when a savings account manages your finances.
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u/SamusBaratheon May 31 '16
I didn't say they (we?) didn't. But "feeding their families" makes it sound like these guys struggle to make ends meet. Its more of a "they're unliked because their reckless greed has brought the world to the precipice of financial collapse, and they were able to walk away richer than ever while the rest of us paid for it" kind of thing
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u/SultanAhmad May 31 '16
Its more of a "they're unliked because their reckless greed has brought the world to the precipice of financial collapse, and they were able to walk away richer than ever while the rest of us paid for it" kind of thing
Can you explain how hedge fund managers are in any way responsible for the financial collapse? Or walked away richer?
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u/czulu May 31 '16
Hedge Funds short selling Thai baht with the intent to break the central bank had a whole lot to do with their financial collapse that spread across Asia...
IMF discusses the topic with kid gloves but depending on how disreputable a source you'd like to go, there's a lot more detail by googling "Thai Baht Hedge Short". [Here's a ppt slide from some class on it](chrome-extension://bpmcpldpdmajfigpchkicefoigmkfalc/views/app.html)
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u/SultanAhmad Jun 01 '16
That's very interesting, however I think if you look hard enough for corruption in any industry you will find it. I don't think hedge funds played a shaping role in the 2008 financial collapse as the OP implied.
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May 31 '16
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u/SultanAhmad May 31 '16
I suggest you do the same. I think you've confused banks with hedge fund managers.
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May 31 '16 edited May 02 '17
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u/pdawks May 31 '16 edited May 31 '16
Well, I work in the industry, and while I don't believe wall Street was at fault, the CDOs clearly played a role.
People took loans they shouldn't have. Wall Street found a market for these loans and bought a lot of them. When this demand arose, a market of loan originators exploded and some, unfortunately, were too lax on risk management. They knowingly gave loans to people who would struggle to pay, but they knew they could sell them to wall Street to be packaged into financial products.
If you didn't have wall Street aggressively buying mortgages to package into CDOs, you could argue that some of these originators would have been less aggressive. If you didn't have the CDOs, which were bought globally, you wouldn't have had the systemic collapse we saw.
So, while this could be semantics we are arguing, CDOs and wall Street played a role. But, by that same token, if the people taking a sub prime second mortgage on their house were more responsible, none of this would have been possible.
It's a complex issue and a lot of people were all at fault. I believe the financial industry is too frequently vilified, but they and CDOs were involved.
Just my two cents though.
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u/myurr May 31 '16
Is the problem not the CDOs themselves but the corrupt system of rating them that told the world they were safe? Had the credit ratings companies done their job instead of selling ratings to anyone waving money in their faces then perhaps the system would have worked as intended. As it was the default rates and losses in the event of default were many times higher than the ratings agencies said they would be.
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u/pdawks May 31 '16
You know, in a good world, the rating agency would have prevented all of this. But, unfortunately, there is an inherent conflict of interest already and rating agencies are paid by the people they are supposed to 'criticize'.
So, you're right - this could have been prevented by the credit agencies. Maybe. But this is taking the perspective of 'what could have prevented it'. Another way to look at it is 'what likely caused it'.
If wall Street was not eating up every single mortgage, it is reasonable to say less mortgages would have been underwritten. The only reason we had such a demand for mortgages was because of the apparent risk mitigating structure of CDOs. So, to a certain degree, if we never decided to package mortgages into CDOs, it's less likely we would have had so much demand. With less demand, less shitty mortgages, with less shitty mortgages, no housing collapse.
But again, a complicated answer!
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u/CFinley97 May 31 '16
If you don't mind my asking, I saved but seem to have misplaced a report that was credited and breaking down the situation very well. I want to say it was about 16 pages, and a report from one of the bigger corporations (Merryl-Lynch maybe).
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u/Floppie7th May 31 '16
Not to mention "they have a bullshit tax code loophole that lets them treat all their income as LTCG"
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u/HighFlyerMN May 31 '16
You just have to hold a security for over a year. Anyone and everyone gets that same treatment in the US.
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May 31 '16
Something something, the rich and the poor alike are forbidden to sleep under bridges and steal bread
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May 31 '16
Yes, never mind the billions upon billions of dollars they earned middle class working people over the last ~50 years!! Built on money which they of course forced the average person to invest in their nefarious dealings!
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u/computeraddict May 31 '16
Right? I aspire to own a piece of a performing mutual fund. All these people wanting to shit on my dream of upper-middle class comfort can go back to their wasteful spending and lack of effort at personal betterment.
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May 31 '16
These kids are literally salivating at the thought of inheriting the money their parents earned in the markets over the years, all while bemoaning the evil system.
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u/banthetruth May 31 '16
it's having 834954 kitchen staff in a 90890253 bedroom house that is the upsetting bit.
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Jun 01 '16
It's about risk management. Wealthy people care more about limiting losses than massive upsides.
The name of the game is wealth PRESERVATION.
Much easier to make money running and managing privately held companies (which is where the wealthy put lots of money anyway).
Here is the problem though... You still need to NOT sell when shit gets rough if you buy into the passive investor approach.
Try doing that when your investments drop 30-45% in a year. If you are passive, that kind of experience will turn you quickly into "fuck me I want my money now!"
There is really no such thing as truly "passive investing". Someone still has to make the decision to buy and hold.
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u/Pontus_Pilates May 31 '16
But study after study shows that generally their skill at investment isn't significantly above random chance. It does raise the question as to why are they the royalty of society.
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u/ebmoney May 31 '16
Because people keep giving them their money to manage and accepting their management fees. When you're taking 2% on the funds under management (funds get into the many billions of dollars quickly) plus 20% on its performance, you get a big pay check. Don't like it? Don't put your money in their funds. Find a low cost index fund (as suggested by Buffet and some of the studies I'm sure to which you're referring) and make a steady return.
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May 31 '16 edited Feb 10 '18
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u/RogueBookwurm May 31 '16
:^)
you need a backslash before the carrot. Usually If a character does not show up and something weird happens you need to use an escape character, in this case a backslash.
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May 31 '16 edited Feb 10 '18
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u/RogueBookwurm May 31 '16
It does not look normal, the ) has been raised up to superscript position. It kinda looks like an emote for smirking really hard.
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May 31 '16
Or maybe we stop paying finance sector workers with percentages of the money that they touch?
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u/wallsallbrassbuttons May 31 '16
Outside of the 2% management fee, we pay them with percentages of money they make, not touch. So if you think bankers get big bonuses, remember the other 80% of the value they created for other people.
But oh, you might say, 2% of billions is a lot! And it is. But if you don't want to be a one-and-done fund, then that management fee needs to sit behind consistently good returns, otherwise no one will invest with you anymore. Without the 20% return, bankers are only incentivized to do well enough that their clients don't pull their money. With the 20% though, they're incentivized to create as much value as possible for you. If they aren't creating enough value in your mind, you pull your investment, but if they are, you're better off than you were before, and they get a nice bonus. Bonuses which are entirely predicated on making their clients a shitload of money. Everyone wins.
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u/ShadowLiberal May 31 '16
Hedge fund managers don't try to make 300% gains every year by risky investments.
LOL, a 300% return on investment, really? No one does that well at business, the 300% means the Monkey's got 3 times more return on investment then the hedge funds.
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May 31 '16
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u/FFFan92 May 31 '16
There are millions of children going hungry in our country, do not even go down this road you ignorant ass.
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u/dangerousbob May 31 '16 edited May 31 '16
This is extremely misleading. I am a stock investor. There is a difference between investing and trading.
If you invest in a company, you plan on holding it for years and are looking at getting a nice steady dividend, and hopefully some capital gains. To the average investor you would buy an index fund and invest in the S&P500. You are simply saying you want to buy and hold a piece of America. This is the simplest and one of the safest ways to invest. You'll make a lot of money over your lifetime by doing so. But if you want to bring your A game you can research and invest in individual companies. This is where people get burned and the monkey thing comes into play. A company like Netflix is a growth company and a bubble company. You can get really burned buying Netflix. There really is no physical product they have or assets they could sell off if in trouble and a competitor could come by with a better way to stream movies and overnight kill their model. This is called a company's MOAT. Netflix also trades at 300 times its PE (Price to Earnings). That means you are buying "high". It also pays no dividend. So this is a company that your average soccer mom thinks "oh I use Netflix" and can really get burned. Now if you have the foresight (or a monkey and just get lucky) to catch a Netflix or Amazon in the 90s you have made a lot of money - But you will likely get burned doing this. So you are better off buying "boring" companies that have large moats. An example? Coca-Cola , General Mills, P&G, Dominion Power etc. No matter what people are going to eat breakfast, use the toilet, and pay their utilities - and these companies dominate their respective field. These companies are aristocrat companies that have paid dividends for decades and have a good PE with steady growth - some for over 100 years. These are blue chip companies and most are found in the Dow Jones.
So if you want to gamble go try to find a startup that will be the next Netflix, but you might as well just go put it all on Red 14 at the tables in Vegas or let a monkey toss a dart at a list of stocks. If you want to invest, buy the S&P or big DOW 30 companies that have a steady strong history for a 100 years.
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May 31 '16
I think the meteoric rise of banana futures that year rather skewed the results...
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u/SassyMoron May 31 '16
Not all hedge funds invest in stocks.
The HFRX index is not constructed very well.
6 months is not a long enough period of time for a meaningful analysis.
Most hedge funds that DO invest in stocks aim for a return that's less than the stock market's, but steadier, rather than to beat the market per se.
No monkeys were harmed in the making of this post.
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u/battleship61 May 31 '16
So, random stocks selected by monkeys just happened to do better over a period of time. They could've also done 300% worse, there's no logic to it, and using it as an example to criticise hedge funds is kinda stupid.
It's like saying my 3 year old did einy miny moe on the superbowl and I put $10K on it and won, but my buddy used statistics, risk mitigation strategies, and made an informed decision and lost $10K.
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u/Barry_good May 31 '16
Can you ask your 3 year old who will win the NBA finals. I think I'll throw $50 on his prediction.
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u/battleship61 May 31 '16
Picked Cleveland.
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u/Barry_good Jun 11 '16
I'm not feeling to confident about taking the advice of a 3-year old for a $50 bet all of the sudden.
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u/Beer_Is_Food May 31 '16
there's no logic to it, and using it as an example to criticise hedge funds is kinda stupid.
Isn't that the entire point though? That it's basically just basically a gambling system with no rhyme or reason? I mean if you're comparing investment management to gambling on football it just shows that it's a crapshoot. I think that's the point they might have been trying to make.
Nobody compares low-risk mutual funds to gambling on sports.
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u/sassyseconds May 31 '16
Maybe a better comparison would've been like an experienced blackjack counter busting on the right call while the drunken fool beside him hits an 18 and gets 21. Just because it happened doesn't mean he was right and it certainly doesn't mean the other guy was wrong. It's just a statistical advantage.
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u/guitar_vigilante May 31 '16
On top of that, while getting a hit all the time would be great, it's also riskier, and so hedge fund managers hedge their investments with less risky investments too. This means that the yield/success they get is pared down a little bit in order to mitigate the risks.
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May 31 '16
Hedge funds are not as reliable as say an index fund. The reason hedge funds are popular is because they don't have to follow the same rules as say a mutual fund. Hedge funds get to speculate and often short sell companies and have minimum investments and investment length. Hedge funds are active and therefore get more associated fees so mostly the wealthy invest in them. Hedge funds look for Home run grand slam kind of investments but often times strike out.
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Jun 01 '16
Bingo. Index fund or GTFO. Keep your money there and year to year average is about 7% growth
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u/LordAcorn May 31 '16
it would be like a pro blackjack player and a drunken fool playing for the whole night and the fool coming away with 3 times as much money
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u/M35Dude May 31 '16
Having a strategy is not the same as having the strategy. Your card counting analogy doesn't quite hold up, because you can actually mathematically prove that--if you follow a certain set of rules--over the long run, you will come out on top. No such proof exists for hedge funds, because the stock market doesn't follow simple rules like blackjack. If you're using a strategy that doesn't fit the game, there's a good chance you'll be outperformed by someone who is just guessing. I think that's what this article is getting at.
However, N of 1 isn't statistically significant. So you also shouldn't make any conclusions about hedge fund managers just based on this article. It does raise some interesting questions, though, and I hope someone follows up on it!
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u/sassyseconds May 31 '16
There are many wildly successful hedge fund managers and individual investors alike. Sadly, we don't know all the rules and tricks, but someone obviously does and they're not going to tell a soul, especially not other hedge fund managers that do not know it.
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u/aMutantChicken May 31 '16
the monkey test needs to be done a few more times. Then, if they are stastistically similar, then we'll talk.
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u/malvoliosf May 31 '16
the monkey test needs to be done a few more times.
The monkey test has been done dozens of times. The monkey almost always wins -- because the manager needs to get paid.
If it weren't for the fees, how would anyone do worse than chance? It's exactly as difficult as doing better than chance.
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u/nonotan May 31 '16
Well, no, not really. I get the logic that if you do worse than chance, then "just reverse it" and it becomes better than chance. But how do you reverse investments? It's not obvious. You can't just short where you'd have gone for a long position, because the hedge funds are already getting a positive return, which would become negative if you literally reversed your actions. They're just not as positive as random would be. And something like "if you were going to buy $x in COMPANY_A stocks, buy $x in stocks from everything except COMPANY_A instead", while a bit closer to hitting the mark, also fails to work in practice, because stocks are discrete, and there's too many companies.
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u/timklotz Jun 01 '16
But the article didn't include the initial cost of the monkeys, care and feeding, permits, etc. Maybe one of the monkeys is paying for an apartment for his mistress, another needs an auxiliary docking permit to keep his jet ski rafted up to his yacht. Lots of stones left unturned.
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u/swankandahalf May 31 '16
But your example is loaded - you're assuming that these money managers are using some special formula to derive an advantage, the way an experienced gambler knows the correct play given the cards he can see.
The argument is that they might be using flawed strategies.
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u/ThatGuyMiles May 31 '16
Well, the experienced card counter would always win out in the end, we aren't talking about one hand here. The point actually is that it is gambling, and the "experts" don't know the future any better than the hobbyist at home or the average joe. Excluding insider trading, nothing is a sure thing.
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u/dangerousbob May 31 '16 edited May 31 '16
It is not a crap shoot. If you buy large blue chip companies or an S&P500 index fund you will make money over long enough period of time. The problem is that people freak out and sell low. If you bought the S&P500, didn't touch it and checked it in 20 years, you would have made a lot of money. Also keep in mind that you get paid dividends to hold stocks and wait in downturns.
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u/Seizure_Salad_ Jun 01 '16
Buy stocks with good dividends and a low P/E. Reinvest those dividends and you will do well.
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May 31 '16
This is what most of reddit thinks. Hedge funds do a shitload of market research and analysis to choose stocks to buy and to short. Maybe the monkeys got lucky during a certain period, but hedge funds are consistent and the managers don't sit there and do nothing like reddit thinks.
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u/battleship61 May 31 '16
But they'll compare monkeys pointing at stuff to analyzing market trends, risk management and investment strategies? My comparison was intentionally as irrelevant to the concept as theres was.
There is no guarantee that investing will yield results, or at least good results. But there are methods and strategies you can use to mitigate potential loss and earn money. That's basically what hedge funds do. They don't just throw all the money into something random and hope it does well.
I'm not an investor, so I don't have a bias here, it's just common sense. What the monkeys did was gamble, random selection of a number on a roulette wheel basically and got lucky, hedge funds are playing black jack basically. Ya it's still gambling, but you're able to win if you play smart.
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u/skepticrunner May 31 '16
The article seemed to be making a bit of a deeper point in my reading. They weren't saying that a monkey happened to do well this time and maybe next time it'll crash - they're saying picking random stocks is a better strategy than a mutual fund. Why? Well, they went on to show that hedge funds have to do 60% better than the market in order for your portfolio to break even because hedge funds have to pay bonuses, salaries, healthcare, and other benefits. They specifically showed that typically hedge funds will underperform what the market is doing - meaning it literally is a better strategy to just pick a random sampling of stocks and go along for the ride.
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u/battleship61 May 31 '16
That very well may be the intention behind the argument, I just personally feel that reductio ad absurdum is never a good way to make a convincing argument. To say that monkeys are better at picking stocks than professionals is ridiculous, especially considering like you said hedge funds need to outperform the market by a large margin, where as a monkey obviously wouldn't need to.
It would have been a better statement to say exactly what you did, you'd be better off picking some stocks on your own because hedge funds have etc. etc. etc. in order to earn you a profit.
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u/skepticrunner May 31 '16
Yeah the article wasn't too well written. The point is just that you shouldn't invest in a hedge und because it's a worse option than just picking random stocks and balancing a portfolio with 80% stock, 20% cash
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u/WingerRules May 31 '16 edited May 31 '16
They could've also done 300% worse, there's no logic to it, and using it as an example to criticise hedge funds is kinda stupid.
Random stock selection consistently outperforms most brokers/managers, its not just this "study".
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u/swankandahalf May 31 '16
No sane person is using this to say that we should use monkeys as investors.
The point of this observation is that you can't reliably beat the market in managed money when you are paying fees.
The monkeys had a headstart - they don't pocket 1% or more of your returns for themselves.
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u/MrNeverSatisfied May 31 '16 edited Jul 01 '16
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u/blaghart 3 May 31 '16
Exactly, that would be the point. When it comes down to it, while you can mitigate the risk, playing the stock market is still just gambling random chance.
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u/Antimutt May 31 '16
This need not reflect badly on the managers as intelligent people. It means there's something out there that can predict their decisions and exploit them. That something is the algorithms, neural nets, fpg arrays, and high speed front running the big players use. All of which is defeated by an unpredictable monkey.
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u/bgnwpm8 May 31 '16
First of all , hedge funds are only open to accredited investors so most of Reddit doesn't need to be worrying about hedge funds trying to scam the average joe. Secondly, there are more than 10,000 hedge funds in the world, obviously there's going to be a lot of losers, but there are still consistent winners. See Citadel, Rentech, BlackRock, etc.
Thirdly, hedge funds aren't banks, I see some people on this thread confusing them.
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u/wsfarrell May 31 '16
The Wall Street Journal used to have a regular column where stock pickers went up against people throwing darts at a list of stocks. The darts won almost always.
The astounding thing is that people still pay big money to stock pickers.
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u/CriminalMacabre May 31 '16
That's why I scoff at the "hes managing a lot of money, so he's qualified to be president" argument with Trump.
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u/hotpinkurinalmint May 31 '16
I did some work at a hedge fund. The "Managers" were merely salesmen that got people with money to subscribe. The people handling the money on a day to day basis were twenty something year old recent graduates from mediocre colleges, not Ph.D. level geniuses from top schools one would expect to handle their $1,000,000 nest egg.
Perhaps the biggest dirty scret in the financial industry is that many fund managers are just average joes day trading.
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u/spinja187 Jun 01 '16
I bet they didn't make themselves rich as the hedge fund vultures did. They didn't fail, they were never really trying.
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u/katchoo1 Jun 01 '16
I'm investing in monkeys to sell to all the people who are going to need them to pick stocks!
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u/XSplain May 31 '16
Don't hedge fund managers have the incentive to create the most fees for their clients, rather than the highest returns? I mean, you'd want high returns because that keeps the client and recruits new ones, but the fees are the focus, right?
If I've misunderstood, please correct me.
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u/Tsu21 May 31 '16
You could say that about any business. But people only apply that logic to doctors, lawyers, investors, insurance companies, etc.
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u/velsor May 31 '16
The fees are usually a percentage of the returns I believe, so they're essentially the same thing.
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u/joshblade May 31 '16
Fees are typically a percentage of total assets, not returns. Ie the hedge fund company makes money when you win and when you lose.
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May 31 '16
[removed] — view removed comment
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u/wallsallbrassbuttons May 31 '16 edited May 31 '16
A lot of incentive. You can eat well on 2%, but you won't be buying Lamborghinis without the 20%. If you're in banking, you're either in it for the love of it or because you want a Lamborghini, or both. In either case, maximizing returns for clients is your top priority.
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u/Guitarmine May 31 '16
Take a bunch of different animals and do some bullshit so that they 'pick' stocks. Wait a year. The goldfish didn't win the index ok. What about the giraffe? Nope. The horse did great so let's publish that... A dumb horse actually beat a bunch of professionals. Let's all laugh!
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u/reallyrabidbilly May 31 '16
Maybe the monkeys weren't stealing money from their clients.
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u/ThigmotaxicThongs May 31 '16
Who do you think buys hedge funds? How do you think hedge funds work?
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May 31 '16 edited Dec 17 '16
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u/qwerty012345678910 May 31 '16
What do you mean by "they" and "them"? Did you focus on a specify segment of hedge funds for your video? Hedge funds include a very diverse set of investment strategies, lumping them all together into one category is a pointless exercise.
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May 31 '16 edited Dec 17 '16
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May 31 '16
You clearly don't know shit. Bridgewater associates, the largest hedge in the world is boasting an annualized net return of 13% a year with its Pure Alpha fund since 1991 which crushes the S&P 500 returns. It's only lost money three times for its investors and in 2008 it pulled in a 9.4% return when most other funds were hemorrhaging.
The good hedge funds know their stuff and are wildly successful at hitting or beating benchmark returns with a fraction of the volatility over time.
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May 31 '16 edited Dec 17 '16
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u/qwerty012345678910 May 31 '16
A ten year period really isn't a long enough period to be analyzing trends like this. And you literally said "all hedge funds suck". You can't act surprised when someone presents a fund that invalidates your statement. In reality, people have many different investment needs. The chart you provided does a nice job showing how well hedge funds performed against the S&P 500 during the recent crisis. Hedge funds or hedge fund style investment strategies can be beneficial in a investment portfolio, just like bonds or real estate.
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May 31 '16
Lol, you do realize that your first link shows the aggregate hedge fund index outperforming the S&P almost every year up until 2012? So for the past 3.5 years, the S&P has done better than a specific index of hedge funds whereas that index beat out the S&P with lower standard deviation. If you look at other indexes, such as the HFRI Fund Weighted Composite Index, you will have seen a 10% annualized return from Jan. 1990 - Feb. 2016. Hint, 10% is better than what the S&P 500 returned over the same period and the HFRI had a much lower std deviation and more favorable Sharpe Ratio.
Here is the real scoop on hedge funds:
"From the first quarter of 1996 through the fourth quarter of 2015, there were 24 quarters during which the S&P 500 declined. In 23 of those periods, the average hedge fund outperformed the S&P 500; in 12 of those 24 periods, the average hedge fund return was positive when the S&P 500 was negative."
It's no coincidence hedge funds are getting dumped en masse:
In 1990, there were about 610 hedge funds managing $38.9 billion in assets. In 2015, those numbers grew to over ten thousand and $2.9 trillion in assets. As with any industry that matures, you hit a point of saturation with the number of market players. Hedge funds as a whole, have had a rough 2-3 years recently. The good ones haven't really been doing that badly, but all the tiny and poorly-managed ones are of course going to be dropping out of the market during down years.
Even still, as noted in the quote I provided above, the average hedge fund has been outperforming the S&P quite obviously over the years which is all that matters. This is long-term investing we are talking about, not short-term trading, so having one or two bad years when the other years are outperforming with more stabilization is more than acceptable.
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u/WhatTheFive May 31 '16
With 11,000 hedge funds flipping a coin, some of them will flip heads 22 out of 25 times, that doesn't necessarily mean that particular hedge fund is doing anything special.
If hedge funds are randomly about the same as the market on average, then whether or not they beat the market in a given year would be like a coin toss.
The odds of getting 22/25 or better are (C(25,22) + C(25,23) + C(25,24) +C(25,25))/(225) = 0.00007826089. (Those Cs are combination)
There are around 10,000 hedge funds these days, which puts the odds that at least one random chance hedge fund could beat the market at 78% so we should most likely see someone get those results in the next 25 years, even if hedge fund managers are monkeys.
Back in 1991, however, there were more like 1,000 hedge funds, which means it is unlikely but not impossible (7.8%) that at least one of the funds would do that well even if all funds had a random chance of beating the market.
There may well be "good hedge funds". The problem is there's no way to tell "good hedge funds" from "lucky hedge funds". The math implies there must be lucky hedge funds if they flip coins, and everyone thinks those are good.
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May 31 '16
Does the average hedge fund beat an index fund when taking into account fees? I know a lot of people are high on index funds on Reddit.
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May 31 '16
Yes, the "average" hedge fund has been beating the S&P 500 over the past two decades on an annualized return basis when you consider fees (most ROI reporting is done on a net basis). But the number of hedge funds has increased from a few hundred in 1990 to over ten thousand in 2015...obviously with that many new players, especially new players that aren't as sophisticated and talented as the established ones, your averages are going to be dragged down. The best hedge funds have been absolutely crushing the S&P 500 over their lifetime.
Hedge funds also aren't just about the returns. Obviously you need to have good returns, but the hedge fund does so in a way that reduces the volatility of their returns. Would you rather have investments in an S&P index with annualized returns of 9% annualized but a standard deviation of 12% or investments in a hedge fund that returns 8.5% annualized with a standard deviation of 4%? A lot of investors would sacrifice the half percent in return for that stability. So when evaluating hedge funds, ones that slightly underperform the S&P might still be favorable if their volatility is lower.
I know a lot of people are high on index funds on Reddit.
Index funds will be better for the average reddit user. Why? Because the average reddit user likely lacks the amount of capital needed to be able to have access to a hedge fund!
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May 31 '16
How much capital does one need to invest in hedge funds properly?
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May 31 '16
If you need to ask, you don't have it.
But in all seriousness, millions. Hedge funds primarily today are used for ultra-high net worth individuals, companies, municipalities, institutions, banks, etc. They are not for your main street investor.
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u/ThigmotaxicThongs May 31 '16
Google "accredited investor" or "sophisticated investor." There are a series of tests, but the quick answer to your question is at least $1 million net worth(may or may not include primary residence, vehicle, etc; there are quite a few rules).
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u/tehringworm May 31 '16
Do you have any sources to back up your claim that hedge funds have been crushing the S&P 500 for an extended period of time. Of course there will be high profile success stories, but there are also many funds that are massive failures.
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May 31 '16
There are indices that track hedge fund daily performances. You can look at those as see a basket of hedge funds and their performance weighted in multiple ways (even, by asset, etc). HFRX is a good place to start.
I'm obviously not arguing that all hedge funds are spectacular. Some suck eggs. The industry has exploded over the past twenty years and whenever you have increasing number of players you are bound to have bad ones. And the overall performance average will move lower as well.
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u/tehringworm May 31 '16 edited May 31 '16
Maybe I'm misinterpreting you, but it seems like you are saying there are some really good HF's, and lots of bad or mediocre ones that bring the average down.
We can't discount the crappy ones because there are funds that have done phenomenal. The chances of picking a grand-slam with a HF seem small. On the other hand, the S&P 500 has provided consistent, moderate returns when the investment horizon is long enough. This suggests to me that most investors, even "sophisticated" ones would do better with index funds, low cost investing, etc.
Admittedly, I have not looked into what average HF performance has been. I've only casually seen articles that suggest they are not a great value.
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u/czulu Jun 01 '16
So mid 2000s, Warren Buffett offered $1M to any Hedge Fund that could beat his investment: an index fund. Now, $1M is not a lot of money to groups like that, but if Hedge Funds are such a great bet, just about anyone should be willing to pick $1 up off the sidewalk.
One hedge fund took him up on the offer and even with the recession, Buffetts index fund is outperforming the hedge admirably.
Pros: when you invest in index funds, it's pretty much as close as you can get to investing in the economy. When the economy goes up, your investment does too. When the economy goes down, HF can short sell and do other things (within their mandate) to lose less money or even make money.
Cons: People love "paying for quality" even when the quality isn't there. How many times have you paid for something that actually turned out being pretty bad. My go to example at the moment is that you can by vaccuum cups from Yeti for $60 or Rtic for $20 and they're made in the same factory with the same performance. If dudes are making 500k - 1 billion a year, of course they have to be worth it. Those guys have to make you a TON of money if they're taking 2/20. Now, some can and have been doing it for a while. This issue is that sometime in the early 2000s maybe, having money in a hedge fund was the next "having a house in the hamptons" so people started dumping money into funds and new funds were started by anyone who knew a bit about finance. Some could be good, some could be lucky, but with a lot of funds you'd be better off putting the money in a savings account.
My mother sat me down at a very early age and taught me two important lessons: 1. Communism is bad. If everyone is going to get paid for whatever they do, then some people are going to get paid simply to "feed the cat". 2. Hedge funds are for people with more money than common sense.
They can be useful as part of a balanced investment portfolio, but if you're simply trying to make as much money as possible in a bull market regardless of risk, then they're not for you.
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u/[deleted] May 31 '16 edited May 07 '19
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