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The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True Hardcover – January 3, 2012
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"Simon Lack, a hedge fund veteran exposes some unforeseen and uncomfortable truths about the industry in his new book." (Hedge Fund Net, January 2012)
"...a cautionary tale from one who knows just about all the tricks...an easy, largely fun and certainly instructive read" (Financial World, February 2012)
"Devastating little book.... His conclusions will make uncomfortable reading for many self-styled 'masters of the universe'.... This book should be required reading for pension fund trustees." (Jonathan Ford, Financial Times, 19th February 2012)
From the Inside Flap
Sure, hedge funds have produced some of the greatest fortunes in recent years, but the shocking reality is that investors would have made more putting their money into treasury bills instead. And while hedge funds have proved to be serious moneymakers for those that manage them, investors themselves rarely reap the benefits. In The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to Be True, hedge fund expert Simon Lack blows the lid off the secret world of this class of investments, teaching you everything you need to know to maximize your own returns.
Drawing on an insider's view of hedge fund growth during the 1990s, a time when investors in the field did well in part because there were relatively few of them, The Hedge Fund Mirage chronicles the history of the hedge fund, highlighting the many subtle and not-so-subtle ways that returns and risks are biased in favor of the fund manager, and how investors and allocators can redress this imbalance. Packed with information about the industry and what's wrong with it, the book steers you away from the traps that befall so many investors. Full of helpful pointers on how to really get the most out of your hedge fund investments, it encourages using new and emerging hedge fund managers whose returns are generally better, negotiating more assertively for stronger investor rights, and warns anyone putting their money in the hands of a manager to demand complete transparency at all times.
Hedge fund investors have had it tough in recent years, but that doesn't mean that there isn't money to be made. As the success of hedge fund managers shows, opportunities are there. The dilemma for investors is figuring out how to identify managers you can trust and learning the techniques to keep more of the money generated using your capital. The Hedge Fund Mirage is here to help, turning the tables on conventional industry wisdom to put you, the investor, back in charge.
Top customer reviews
Consider the plight of a pension fund manager. They are charged with investing money in such a way that in the future it will give the participants better returns that they could have received from investing in Government bonds. These returns would have to include the costs involved in handling this money. This is a feat that requires exceptional investment skill based on deep understanding and insight into finance and economics.
For this reasons pension fund managers invest in hedge funds with the expectation of yields higher than those on safer investments. Hedge funds are aggressively managed portfolios of investments that use advanced investment strategies such as leveraged, long, short and derivative positions for the purpose of generating abnormally high returns.
Hedge funds are not a new vehicle, the first fund was founded in 1949, but the recent growth of this industry has been staggering. In 1998 Lack estimates hedge funds had assets under management of about $140 billion and almost $1.7 trillion by 2010.
The “mirage” referred to in the book’s title is the false tendency to count on hedge funds to deliver for the investors and to deliver for the investors in fair proportion to what it delivered for the hedge fund managers. In fact, Lack argues very cogently, it is the operators of hedge funds that get rich and in some cases, obscenely rich, but not the customers. He titles one of his chapters: “Where are the customers’ yachts?” Lack also argues very cogently that hedge funds have not delivered on their purpose. If all the money that has ever been invested in hedge funds had been invested instead in boringly safe, but reliable, Treasury Bills, the results would have been twice as good.
In 2008, instead of protecting wealth in these troubles times, the hedge fund industry lost more money than all the profits it had generated in the previous 10 years. 2011 was another bad year for the industry which was down by 6.4%, and yet the assets under management have climbed to $2 trillion.
How can this be?!
Hedge funds are most often set up as private investment partnerships that are open to a limited number of sophisticated investors and are therefore not required to report their activities to the SEC. This is why it is requires Lack’s proficiency with numbers and his insight into the industry to give a clear picture through the mirage. What he reveals is an industry where the returns and risks are biased in favour of the hedge fund manager and where there is surprising frequent fraud.
There are many ways in which one could report the performance of hedge funds and it is clearly in the interests of the industry to report these results in the most favourable terms. The typical way of reporting is on a time-weighted basis which reflects the performance of the hedge funds over time. This allows for the early, small funds, which produced the best returns, to mask the poor performance of the large funds. However, if you report performance based on a money-weighted basis, the amount of money in the funds, a very different, but more accurate picture emerges.
From 1998 to 2010 the industry returned only 2.1% annualized on a money-weighted basis, not 7.3% as indicated when the time-weighted basis is uses! Calculated this way, during this period hedge fund managers earned $379 billion in fees, while the investors earned only $70 billion in profits or 84% versus 16%. This is achieved because hedge fund operators take incentive fees in addition to operating fees with no downside if they perform poorly and lose investor’s money.
If the situation is this bad, why have we been thinking it was so good? Clearly a larger part of the answer lies in the way some operators report their results and how they are able to get away with reporting only when they have racked up a good score. However, there are also inherent flaws in the system.
It is far easier to find great investments in small quantities than it in large quantities – they are great because they are so much better than all the rest. As a hedge fund does well through these rare finds, it is able to attract larger amounts of money for which it now has to find even more rare finds, which gets ever harder to achieve. During the 1990s when hedge fund investors did well it was in part because there were relatively few of them.
The truly outstanding hedge fund operators like George Soros and John Paulson have built famously huge fortunes, the reward for truly outstanding performance. The problem is that a few dozen have produced most of investors’ returns, and as with actively managed unit trusts, it is difficult to identify the strong performers in advance. Investing in new hedge funds involves a bet of millions of dollars on the stock-picking ability of an individual and there is always the ever present danger of latching onto a fraudster like Bernie Madoff.
Lack lays the blame for the lopsided rewards of the hedge fund industry largely on the supposedly sophisticated investors, such as pension funds, and their consultants. “Star-struck investors have too often equated enormous financial success amongst managers with high returns for clients… Faulty or weak analysis, performance chasing, shortage of scepticism, and a desire to be associated with winners without proper regard for terms have all caused the sorry result.”
This is a book that will inform professionals and fascinate anyone interested in investment.
Readability Light ---+ Serious
Insights High +---- Low
Practical High ---+- Low
Ian Mann of Gateways consults internationally on leadership and strategy
All this is somewhat entertaining and educational until we focus on his main argument- That HFs have taken 80%+ of the industry's excess profits relative to their clients' gains. The math doesn't seem to add up if I'm reading it correctly. He seems to take NET HF returns and then apply fees to those returns to demonstrate how large a cut the industry is taking. This grossly overstates the size of the fees relative to client returns and makes it hard to believe the point he is trying to make (though he has a point that fee structures and payouts need to be changed in a manner more favorable to clients.)
Also, his big question that he thinks will awaken the masses to the charade that is HF investing is, "Can you name a rich HF investor- NOT manager?" This is a diversionary tactic. Let's say a HF manages $1B and has a 20% year, his 2 & 20 will net him $60M in total fees thus making him "rich"- but someone(s) had to give him that $1B to begin with- the already rich. The vast majority of individual HF investors are ALREADY rich and most very private. Since they're not the ones making the big bets or blowing up they don't get on the cover of the WSJ, nor do they want to. The Bass or Ziff family has seeded and invested in a number of HF & Private Equity firms and have done very well for doing so. So this "great conundrum" isn't so strange after all.
In the end, it's a good book with some interesting and salient points to help those who may invest in HFs, but it's nowhere near the HF Mitchell Report Mr. Lack thinks it is.