Chat with us, powered by LiveChat Some of you found hedge funds interesting, not worth the cost, in need of regulation, play an important role, manager pay is - School Writers

Some of you found hedge funds interesting, not worth the cost, in need of regulation, play an important role, manager pay is

Some of you found hedge funds interesting, not worth the cost, in need of regulation, play an important role, manager pay is right on if the market accepts it, pay is too high, not easily replicable, how do they do it, Warren Buffett argues sub-par performance, what’s all the fuss… There has clearly been a push back on hedge funds, including some by pension funds that are demanding fee changes. The 2/20 management and performance fees are being pushed down by recent investor requirements that funds exceed high water marks, payment on performance fees only for returns that exceed Libor plus the fund’s management fee, and decreasing management fees as the size of an investor’s allocation to the fund grows. These changes will help in realigning the fee structure and perhaps increase net returns, while some hedge funds are shutting down (see the attached recent article “Quitting while they’re behind…” and tongue in cheek article on “The lexicon of hedge funds…

Many of you expressed some agreement with the idea of borderless investing, while others had some reservations. Related to this borderless investing approach, there has also been an explosion of country ETFs (exchange-traded funds). According to BlackRock (a financial firm quoted recently in the Economist), late 2000 year-end ETF assets under management topped the $1 trillion mark for the first time — whereas the industry’s assets were just $40 billion at the end of the late 1990’s. Emerging markets and commodities were among the fastest-growing ETF types in the late 2000s.

Our focus until now has been on financial products and markets, but there are clearly other forms of capital. The attached article, “A question of trust” discusses the role of “social capital.” It is clear that social capital matters on several dimensions. While the attached social capital article is from some years ago, is “social capital” important in business and capital markets? Do you have any insights in this regard from your personal or professional experience?  I hope you have a great Thanksgiving later this week.


Feb 18th 2012 | LONDON AND NEW YORK | from the print edition

Hedge-fund closures

Some hedge funds are throwing in the towel

THE past few years have been “as miserable as I can remember”, says Johnny Boyer of Boyer Allen Investment Management, a British hedge fund focused on Asia. The fund, which looked after $1.9 billion at its peak, faced the prospect of spending the next few years trying to claw its way back to pre-crisis asset levels. Instead the founders decided to shut the fund and give investors their money back.

Others have also had enough. “I’ve been doing this for 15 years and I’ve never seen as many people give up as in the last three months,” says Luke Ellis of Man Group, a large listed fund. This trend is distinct from the round of closures in 2008. Then, managers were hit by investors’ redemptions and had no choice but to close; today many are electing to walk away.

For some managers, the markets have become too stressful. Running a hedge fund today is “three times as much work for a third of the fun,” says one. But many are motivated by economics. Hedge funds typically get paid a 2% management fee on assets to cover expenses and a 20% performance fee on the returns they achieve for investors. Most funds do not earn performance fees unless they outperform their peak level or “high-water mark”. At the end of 2011, 67% of hedge funds were below their high-water marks, according to Credit Suisse, and 13% have not earned a performance fee since 2007 or earlier.

Funds can survive off a management fee for a couple of years, but four

Hedge-fund closures: Quitting while they’re behind | The Economist

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is a long time to go hungry. Most managers were banking on a recovery in 2011 but the average hedge fund slid by 5.2%—much worse than the S&P 500, which returned 2%. Poor performance is causing changes in the way the industry markets itself (see article ( ). It also means many funds will have to wait even longer to earn a performance fee again. According to Morgan Stanley, 18% of hedge funds are more than 20% below their high-water marks.

Smaller funds have been more likely to close than their larger peers. That’s partly because it used to be possible to run a hedge fund with $75m under management. Today funds need at least double that amount because administrative and compliance costs are higher than ever. Larger funds also depend less on performance fees because their management fees bring in so much cash. John Paulson, a hedge-fund giant whose flagship fund was clobbered last year, has pledged to make up investors’ losses but his fund is so large that he can easily afford to carry on. That risks distorting the original point of hedge funds—that they are small, limber operations which come and go often (see chart).

For investors, it is generally a good thing if underperforming managers are returning cash and not milking them for fees. But others worry that high-water marks could skew funds’ investing decisions. Managers who have not earned a performance fee in years could take bolder bets to get back into the black. Leverage levels have been creeping up. Some may prefer to go out with a bang, not a whimper.

Hedge-fund closures: Quitting while they’re behind | The Economist

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Feb 18th 2012 | from the print edition

The lexicon of hedge funds

The industry’s language is changing

Dear investor,

In line with the rest of our industry we are making some changes to the language we use in our marketing and communications. We are writing this letter so we can explain these changes properly. Most importantly, Zilch Capital used to refer to itself as a “hedge fund” but 2008 made it embarrassingly clear we didn’t know how to hedge. At all. So like many others, we have embraced the title of “alternative asset manager”. It’s clunky but ambiguous enough to shield us from criticism next time around.

We know we used to promise “absolute returns” (ie, that you would make money regardless of market conditions) but this pledge has proved impossible to honour. Instead we’re going to give you “risk- adjusted” returns or, failing that, “relative” returns. In years like 2011, when we delivered much less than the S&P 500, you may find that we don’t talk about returns at all.

It is also time to move on from the concept of delivering “alpha”, the skill you’ve paid us such fat fees for. Upon reflection, we have decided that we’re actually much better at giving you “smart beta”. This term is already being touted at industry conferences and we hope shortly to be able to explain what it means. Like our peers we have also started talking a lot about how we are “multi-strategy” and “capital-structure agnostic”, and boasting about the benefits of our “unconstrained”

The lexicon of hedge funds: From alpha to smart beta | The Economist

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investment approach. This is better than saying we don’t really understand what’s going on.

Some parts of the lexicon will not see style drift. We are still trying to keep alive “two and twenty”, the industry’s shorthand for 2% management fees and 20% performance fees. It is, we’re sure you’ll agree, important to keep up some traditions. Thank you for your continued partnership.

Zilch Capital LLC

The lexicon of hedge funds: From alpha to smart beta | The Economist

2 of 2 2/25/2012 12:42 PM


A question of trust Feb 20th 2003 From The Economist print edition

Economists are arguing about “social capital”—starting with what it means �

WHAT gives rise to the wealth of nations? Some see the source in rich seams of mineral resources such as oil or coal. Geography matters too: countries in temperate climes tend to be richer, other things being equal, than those closer to the equator. Then there are institutions: the rule of law and (perhaps) democracy. Above these, most economists since Adam Smith have believed, stands the invisible hand of the market, guiding selfish human actions to serve the common good.�

Is there something missing from the list? For the past decade or so, sociologists have been pushing one more concept, “social capital”—trust or community, in one of its guises—that is now also being taken up by economists. Crudely speaking, the more people trust each other, the better off their society. They might work more efficiently together, for example. In business, trust might obviate the need for complicated contracts, and thus save on lawyers' fees. You might expect that America, which has such a successful economy, had social capital in shedloads. Maybe, and maybe not: one of the most influential essays in the field, “Bowling Alone”, by Robert Putnam of Harvard University, pointed out that Americans were far less likely to be members of community organisations, clubs or associations in the 1990s than they were in the 1950s. He illustrated his thesis by charting the decline of bowling leagues.�

A recent set of articles in the Economic Journal* shows how economists are grappling to analyse social capital. On the face of it, the idea that trust or community can make a difference between wealth and poverty does not fit easily with the basic assumption of orthodox economic theory: that humans are essentially self-interested animals. That is why it has an instinctive appeal to “behavioural” economists, who think that this assumption has been accepted too uncritically.�

In one paper, Samuel Bowles and Herbert Gintis, of the University of Massachusetts, advance just such a view. They argue that, if social capital is taken into account, economists have to put aside the idea that people are simple, self-interested economic machines. People donate their time to all sorts of things, from voting to teaching in Sunday school, whose costs outweigh the private benefits. Obviously, argue Mr Bowles and Mr Gintis, humans are social animals.�

This could be explained away easily, though, by making the assumption that people derive utility from helping others at their own expense. But the authors think that something more sophisticated is required. They carried out experiments, using university students, to see how a group of people might encourage each other to act in the interests of the group as a whole. Many subjects, it seems, take pleasure in punishing free-riders. Many respond to the shame of being found out as shirkers, which encourages co-operation. The lesson is that notions of selfish, or indeed altruistic, preferences cannot explain the incentives of people in a village, school or parish. The authors conclude that such communities are the missing ingredient, alongside markets and the state, in understanding an economy.�

No, it does not take a village

In another paper, Edward Glaeser and David Laibson of Harvard University and Bruce Sacerdote of Dartmouth College take individuals, not groups, as their starting point. They also use a more individualist definition of social capital: a person's social skills. This can mean a long list of contacts, a facility for dealing with others, or even just charisma. The authors include popularity in their definition, since it can be the result of investing in personal relationships. They measure people's stock of social capital by the number of organisations—clubs, charities, religious groups and so forth—to which they belong.�

The authors see social capital as something that people can build for themselves, rather as they build financial wealth by saving or investing, or “human capital” by acquiring skills and education. A doctor, for example, might invest in more than just medical education: by joining a local club, she could get to know her patients better and perhaps increase her future income.�

Messrs Glaeser, Laibson and Sacerdote find that investment in social capital, as they define it, has similar characteristics to investment in financial or human capital. People join professional societies, say, when they are young and reap the benefits when they are older, relying on business contacts made early on, just as they do with savings. People also invest more in social capital the more likely they are to remain living in the same place; the “bowling alone” phenomenon may be partly attributed to rising mobility. They also invest more in social capital the more they stand to gain from it. When there is nothing in it for them, they neglect their neighbours. Homo economicus lives.�

By definition, however, decisions to invest in social capital affect not just the individuals making them but others too. It is tempting, if social capital is defined in terms of community or trust, to see such spillovers as always positive. But they may not be. For instance, if people act in the interests of a group to which they belong, others can be harmed: a professional association, for example, may keep fees and entry barriers high, or some groups may exclude outsiders altogether.�

In the final paper in the series, Steven Durlauf of the University of Wisconsin says that research into social capital may have become a bit too other-worldly. Existing data, mostly taken from surveys, are not up to the task of specifying social capital precisely enough. Perhaps too much has been invested in the concept of social capital to help explain why nations become wealthy. As more economists pile into this fertile area, expect more deflation of the concept—and also more argument. �

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