Hedge Funds Are Not the Dark Side of the Force

Financial journalists have made an easy living writing articles on hedge funds based upon a formula. Just as formula writing results in some of the shallower situation comedies in television history, formula hedge fund articles fail to inform potential investors in a comprehensive manner.

Such articles follow the following formula.

Step One

Create a chart of aggregate hedge fund returns as compared to the S&P 500 over the past “x” number of years. The number of years may be decided arbitrarily or intentionally depending on the goal of the author. This chart is then followed by one or two paragraphs of narration, typically deriding hedge funds as an under-performing investment vehicle, which any investor must avoid at his own peril.

Step Two

With, or without a graph, delve into the dark world of industry outflows. These can be defined as net of new investments…or not. Again, the choice depends solely on the author’s intent. The same applies to the number of month or years the author chooses to highlight. This is followed by a few examples of high-profile investors that have fled the industry. Typical examples invariably include CalPERS. Of course, these outflows must be tied to performance.

Step Three

Step 3 requires the author to rage against the exorbitant management and performance fees charged by hedge funds, pointing out the standard 2 and 20 structure (never mind that this is antiquated and hardly representative of the majority of hedge funds today).

This diatribe must be followed by quotes from one or more iconic hedge fund hater, Warren Buffet being the popular choice. Naturally, hedge fund fees must be attributed to negative investor sentiment.

Elements of Truth

While it is true that hedge fund performance, in the aggregate, has been less robust in recent years, these formula articles do not address the fact that most hedge fund investors use hedge funds to avoid exposure to the broad equity market. After all, they could make such an investment themselves and avoid the management and performance fees entirely.

Hedge fund investors are in pursuit of risk-adjusted returns that fulfill a role in their portfolio, which cannot be economically duplicated by internal investment teams. These skills command fees, although rarely 2 and 20. Outflows always take place and, although performance is high on the list of causes, there are many other reasons. More to the point, net outflows are the important benchmark, as many investors will reinvest in other hedge funds.

What about Hedge Fund Jobs

More than ever before, hedge funds are competing with other industries for talent, venture capital, private equity, and Silicon Valley to name a few. It is imperative that job seekers understand the vital role hedge funds play in our economy Five-hundred word articles should not be the basis for a career decision. The machinations of a hedge fund are too complex to be addressed in a few paragraphs.

Remember, one should not take everything one reads at face value. There is always another angle to the story. Do yourself a favor. Before dismissing the thought of a hedge fund career, make an effort acquire an in-depth understanding of this fascinating industry.

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