HEDGE FUND managers treat themselves to absolutely fabulous toys: Ken Griffin is fond of Ferraris, Steve Cohen is known for his Damien Hirst pickled shark and ice rink.
So where are the customers' yachts?
"Who can name even one hedge fund investor whose fortune is based on the hedge funds he successfully picked?" asks Simon Lack in his stinging expose, 'The Hedge Fund Mirage'.
If anyone is qualified to pose that question, it's Mr Lack, whose Wall Street career lofted him through the multiple mergers that begat JPMorgan Chase. His answer ought to drive many hedgehogs -- and their investors -- into hibernation.
Sitting on JPMorgan's investment committee, Mr Lack helped to allocate more than $1bn (€770m) to promising hedge-fund managers, the book says. His conclusion about the broader industry, stated baldly on Page 1, can be boiled down to one statistic.
"If all the money that's ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good," he writes.
Mr Lack isn't saying that hedge funds never reap superior returns for investors. Far from it. He clearly admires John Paulson's bet against the US housing bubble and George Soros's wager against the Bank of England. And the industry did perform well and preserve capital during the 2000 to 2002 bear market, which is why so many institutional investors threw money at them, driving assets under management to more than $1.6trn, Mr Lack says.
Shunning simple average annual returns, Mr Lack measures hedge funds with an index weighted by assets, just as the stocks in the Standard & Poor's 500 Index are weighted by their market value. This gives a better sense of the returns, he argues, because investors in aggregate have invested more in the bigger funds. Then he turns his attention to the real profit killer: fees.
He starts with two data sets: annual assets under management (as tracked by BarclayHedge since 1998) and returns as measured by the HFR Global Hedge Fund Index, which is weighted by assets. Next, he estimates fees using the standard "2-and-20" formula; a 2pc management fee and 20pc incentive fee.
This involves a few simplifications. Some managers, for example, charge more than 2pc and 20pc, some less. Yet the methodology does reveal a clear picture of the total profit hedge-fund investors received minus fees and the return they could have gotten by parking their money in Treasury bills.
From 1998 through 2010, these "real investor profits" totalled $70bn, compared with fees of $379bn, Mr Lack estimates. Adding the fees back in, hedge fund managers salted away 84pc of $449bn in total profits, leaving 16pc for their investors, he says.
The risks and rewards are so cockeyed that Mr Lack can't resist paraphrasing Winston Churchill's encomium about Royal Air Force pilots during the Battle of Britain: "Never in the history of finance was so much charged by so many for so little."
If Mr Lack's calculations are wrong, he can kiss his career goodbye. If he's right -- and I think he is -- pension funds have a lot of questions to answer.
As damning as his analysis is, Mr Lack ultimately concludes that hedge-fund managers aren't the villains of this sad story. The real fault lies with the "supposedly sophisticated investors" who fling so much money at funds with so little scepticism and critical analysis. (Bloomberg)
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