Hedge funds, hedge funds, free investment funds… different terminologies to define the same concept: investment vehicles that operate with maximum freedom. Without restrictions. They can put all their eggs in one basket. They can bet against a company. Or against a country. And they can go into debt to amplify profits (or losses). In the 90s and 2000s, managers of this type of funds symbolized the image of success. They achieved scandalous returns, earned fortunes and squandered shamelessly. But his ascendancy is in decline. The returns of the last decade have been very disappointing and uneven, and money is beginning to flee towards other assets.
In cinema, financial sharks have always been money managers. hedge fundswhether they were fictional characters, such as Gordon Gekko (played by Michael Douglas in Wall StreetOliver Stone, 1987 and 2015), or real ones like Michael Burry (star of The Big Bet, Adam McKay, 2015). They are figures that have entered the collective imagination for their daring, their ability to swim against the current and, sometimes, their lack of scruples. Even George Soros, who to millions of people is the epitome of shadow financial power, became famous as a hedge fund manager.
But, little by little, the wolves of Wall Street are retiring. George Soros is now an endearing 93-year-old man who has handed over the reins to his son. The legendary Jim Rogers (81 years old) moved to Singapore years ago so that his daughters could learn Chinese. And John Paulson (who made his fortune betting on the US housing market crash in 2008, like Burry) retired three years ago and is now focused on his million-dollar divorce.
What has happened to make them lose their shine? hedge funds? Why do hedge funds no longer attract the public? According to the firm Evestment (of the Nasdaq group), between 2019 and September 2023 the hedge funds They have suffered net outflows of $289 billion. The industry still manages $3.5 trillion, but the figure is decreasing.
Perhaps the moment when its decline was clearest was in 2017, when the sector lost the bet that the famous investor Warren Buffett had made (this one, focused on buying listed companies, without further ado). A decade earlier, Buffett had thrown down the gauntlet to the smart guys on Wall Street: a simple fund that replicated the evolution of the US stock market could beat a selection of the best asset managers. hedge funds. The Oracle of Omaha won by a landslide.
In recent years, things haven’t been much better. Since the beginning of 2014, the Bloomberg index that monitors the profitability of all hedge funds It has revalued by 39%, which represents an annual return of 3.43%. In that period, the North American benchmark stock index, the S&P 500, has risen 178% (11% annually). For that trip there was no need for so many saddlebags, nor so many commissions.
One of the factors that makes hedge funds have lower returns than conventional funds is because their managers charge more. The expenses are usually 2% fixed commission plus 20% of the annual profitability.
The black boxes of the sector
- Bridgewater. In the recent article published by The New York Times, it is highlighted that the largest hedge fund in the world, Bridgewater Associates, has never been able to clearly explain how it made money for its investors. It was suggested that the proximity of its founder to major economic figures, from whom he could have obtained information, had been key. The mystery was such that even the supervisor did an investigation to see if it was a pyramid scheme, as occurred with the Madoff case.
- Medallion. In 1988, mathematician Jim Simmons created what would be the most profitable hedge fund in history, with an average annual return over 30 years of 66%, something totally unusual. He used advanced computer programs. Simmons retired in 2010.
Another situation that has generated great dissatisfaction among clients is the great dispersion of results. While the hedge funds The largest funds (Bridgewaters, Citadel, Pershing Square Capital Management…) have continued to beat the markets, the middle class of these funds has increasingly disappointing returns.
Furthermore, they increasingly distance themselves from the evolution of financial markets when this should be precisely one of their strengths. By having maximum freedom when investing – and being able to apply strategies based on making money when the stock market falls – free investment fund managers promised profitability in any market environment. But it has not been that way.
In 2022, as valuations of both stocks and bonds fell sharply, the 20 largest hedge funds posted their worst performance since 2016. In total, the hedge industry hedge funds recorded losses worth $208 billion.
The reasons for the decline
Financial markets have changed radically since the golden age of the hedge funds. The information accessible with a single click is infinitely greater. Same as computing ability. In addition, there are many more players and of a more varied type: from gigantic passive management funds that replicate indices to active exchange-traded funds, to powerful sovereign funds. This variety makes financial markets more efficient. The speed of the operation has also skyrocketed. It is increasingly difficult to find an inefficiency, an arbitrage, that can be taken advantage of without attracting the attention of other operators.
It must be remembered that these types of investment vehicles are not open to all audiences. Each manager sets its conditions and they tend to be very restrictive, often requiring minimum contributions of more than $500,000 and retention periods of more than one year. This means that only institutional investors (such as insurance companies or large pension funds), as well as some millionaires, are the most common clients of the hedge funds.
In Spain, where there are only 4,000 million euros in this type of instruments, a law is being processed so that clients with contributions starting at 10,000 euros can access free investment funds (compared to 100,000 euros now). In any case, here the managers of hedge funds They do not operate as aggressively as the Americans and these vehicles are often used solely to buy companies’ private debt or real estate assets.
Sometimes they are also used so that conventional investment fund managers can market a more distilled investment strategy: concentrated on a few securities, something that cannot be done in a traditional fund. But the results are not satisfactory either. The free investment fund Bestinver Consumo Global FIL has returned only 2% on average annually in the last decade. And the Bestinver Tordesillas FIL adds 1.87%. Meanwhile, Bestinver Internacional, one of the house’s normal funds, has reaped more than 4% APR.
One thousand faces
Being a type of collective investment institutions where almost anything goes to make money, the strategies are very varied. One of the first they used is the call long/short, which is based on combining bullish positions in the companies that are most trusted with short bets in companies that the manager believes may depreciate. In this way, you could make money at any market situation. In theory.
Another variant is hedge funds that have a macroeconomic profile, which look for dysfunctions in the monetary or fiscal policies of countries to take positions. Perhaps the best-known case of a fund of this profile is the short bet by George Soros and Stanley Druckenmiller in 1992 against the British pound, which defeated the powerful Bank of England.
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This is one of the specialties of Ray Dalio, founder of the world’s largest hedge fund, Bridgewater Associates, who retired a year ago. His close relationship with central bankers and economy ministers has allowed him to access very valuable information, according to a article published by The New York Times last week.
Also very popular are hedge funds activists. One of the most visible faces of him is Bill Ackman, the founder of Pershing Square Capital Management. In 2016 he considered that the listed firm Herbalife (specializing in the sale of diet products) was a pyramid scam, due to the way its sellers were recruited. So, after placing a short bet on the firm (to benefit from the devaluation of its shares), he undertook a costly campaign to discredit it. However, he encountered strong opposition from other investors and, after a five-year battle (including several court cases), Ackman had to give up. On that occasion he lost, but between 2020 and 2022 his firm earned $3.85 billion thanks to stock coverage contracted just when the Covid-19 pandemic began to break out.
Another of the last Mohicans of this industry is Paul Singer. With his hedge fund Elliot Management, he entered into a bloody legal battle with the Argentine State for non-payment of the debt. The situation reached such a point that Singer obtained the temporary seizure of an Argentine Navy training ship when it stopped in Ghana.
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