The great hedge fund debate
Back in 2008 Warren Buffett made a $1m bet that the S&P 500 index would outperform a basket of hedge funds over the course of a decade.
Ted Seides, the investor on the other side of that bet, conceded defeat in 2017, after a particularly terrible year for hedge funds.
Buffett was railing against the “2 and 20” fees — two per cent management fee and 20 per cent of performance gains — charged by hedge funds, which he found “ridiculous”.
For many years, when the likes of George Soros and Jim Simons were considered the “masters of the universe”, few investors seemed bothered by hedge fund fees. Returns were so good that they made the fees seem insignificant.
George Soros is among the illustrious hedge fund investors who have converted their hedge funds into family offices since the financial crisis © AFP/Getty Images
But the years following the financial crisis have been difficult for the industry. Hedge fund performance, bar a few exceptions, hasn’t been particularly great and investors have embraced other options, including private equity and passive index funds.
Now the pandemic has brought with it a new sense of optimism. According to this Big Read by the FT’s Robin Wigglesworth and Laurence Fletcher, 2020 was the best year for hedge funds since the aftermath of the financial crisis in 2009. Things are also looking up for 2021, prompting some to ask whether we’ll see a revival of the hedge fund industry.
On the face of it, things look good. Assets have increased (though in fairness, they’ve been on an upward trajectory since the 1990s), fees have come down slightly, and new fund launches outnumber closures.
Consider the fact that hedge funds are starting to make money again, and it starts to resemble something of a renaissance. But has much really changed since Buffett made that bold initial bet?
While hedge funds have made money recently, so has everyone else. While the industry relishes its best year in more than a decade, stock markets are still outperforming, though many managers take issue with being compared to the S&P 500.
Fees have come down somewhat — the traditional “2 and 20” is now on average 1.38 per cent and 15.9 per cent. But that is still expensive relative to what else is out there, and “star managers” tend to charge even more than 2 and 20.
What does appear to have changed is that hedge funds have finally stopped swimming against the tide.
They’ve embraced the booming equity market and are doing well for it. Does that warrant the fees they charge? That’s for investors to decide.