There was a time, not so long ago, when the term “star hedge-fund manager” had a legitimate place in the investment lexicon. Today, however, the sector smacks more of faded grandeur than constellation
Take John Paulson. At the height of the financial crisis, he and his company, Paulson and Co., amassed returns on a gargantuan scale after correctly calling the U.S. subprime mortgage crisis. By reportedly making $3.5 billion (€2.6 billion) in a year as a result, Mr. Paulson became the benchmark of success in the hedge-fund industry. But as market volatility has wreaked havoc upon the portfolios of even the savviest investors, such star managers have become increasingly rare. Even Mr. Paulson has suffered a series of setbacks of late after two of his largest funds recorded losses earlier in the year.
Stellar performance has proved elusive across the investment world. But unlike the more-run-of-the-mill active funds, hedge funds must justify their hefty fees with strong absolute returns or investors will rapidly lose patience. This is particularly true as the year-end approaches and investors’ thoughts turn to redemption.
Investors considering putting money in hedge funds nowadays need to approach their decision with eyes wide open. As a means of diversification, in terms of investor asset allocation, they are still a generally positive proposition. And the fact remains that if a hedge-fund manager has a particularly good year, huge returns are still possible. But if investors are seeking the outperformance on which the industry earned its hard-driving reputation, they will mostly be disappointed. As institutional money has flowed into hedge funds and rules governing them have been tightened, the market has become less exciting. This move into the mainstream means many are now a relatively safe investment. But investors have to ask themselves whether safety is enough of a selling point, particularly in light of the fees many hedge funds charge.
Questionable Fees
Typically, a hedge fund will charge a management fee of 2% and a performance fee of 20%. These figures vary depending on a manager’s track record of success, reputation, longevity or sheer chutzpah. The best-performing–or most self-confident–managers have been known to charge management fees as high as 5% and performance fees approaching 50%. Investors inevitably question fee levels when performance turns out to be no more than mediocre. And in recent times, taken as a whole, the hedge-fund industry’s performance has been just that.
According to Chicago-based data provider Hedge Fund Research, the average hedge-fund portfolio across all strategies was down 3.5% between January and November this year. This is in spite of a positive month in October, when HFR’s weighted composite hedge-fund index gained 2.43%. This gain followed a third-quarter drop of 6.5% from the previous quarter–the fourth-worst quarterly performance on record. Despite these recent woes, fee levels remain stolidly at, or just below, the 2% mark for management and 20% for performance.
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