Hedge Funds Fail When ‘Rock Stars’ Are in Charge

Date: Wednesday, March 17, 2010
Author: Matthew Lynn

The ideal hedge fund should be like a good local restaurant: reliable, high-quality, a loyal group of customers, and unknown to the rest of the world.

Pierre-Henri Flamand is just the latest star trader who should remember this. The 39-year-old is leaving Goldman Sachs Group Inc. to start his own hedge fund.

No doubt, he will attract plenty of attention. Along with dozens of other “rock star” hedge-fund managers, the financial media will be poring over his thoughts, trades and strategies.

And yet, there is one thing both he and his investors shouldn’t forget: The more publicity they get, the worse the performance will be.

Celebrity fund managers usually crash eventually. They attract too much money, they get caught up in their own hype, and many of them weren’t much good to start with. The lesson for investors is that if they want to invest in a hedge fund, the more obscure it is, the better.

Gideon Ozik, of the EDHEC Business School in Nice, France, and Ronnie Sadka, of the Carroll School of Management in Boston, have just published research on how media coverage affects the performance of hedge funds.

You might imagine that the high-profile stars of the industry were also the top performers. After all, why else would their views be constantly sought by the media?

Famous Underperformers

Not so. Ozik and Sadka studied 978 hedge funds over the decade 1999 to 2008, and correlated their performance against media coverage, measured by checking mentions on Google News.

“We document that hedge funds with media coverage underperform no-coverage funds by 3.5 percent annually over 1999-2008,” they concluded.

Of course, there are some exceptions. A few legendary investors, such as George Soros and Eric Mindich, have done well over many years. And yet the idea that the big names don’t really do that well won’t surprise people who follow the industry. There are examples all over the place.

Just think of some of the stars of the European industry. Arpad Busson is one of the highest-profile figures, not least because of his charity work and his former engagement to actress Uma Thurman. But his fund-of-hedge-funds firm EIM SA lost a packet with fraudster Bernard Madoff, and its assets have fallen about $2.5 billion since the start of 2009.

Fallen Stars

Nicola Horlick struggled with her London-based Bramdean Alternatives Ltd. fund, which invested in hedge and private- equity funds, and she ended up selling the contract to manage the portfolio. Likewise, Philip Richards has seen his star fall a long way after the assets of his flagship fund, RAB Special Situations, plunged 73 percent in 2008. Speculating in the shares of failed U.K. mortgage lender Northern Rock Plc put paid to any reputation for reading the markets he may once have had.

There certainly seems to be a curse of publicity. The higher the profile, the worse the performance.

There are four plausible reasons for this.

First, the media coverage is backward-looking. The “rock stars” are featured in the press because of their past performance, but that doesn’t tell you anything about how they will do in the future. By the time they rise to prominence, it might well be that their finest days are already behind them.

Second, they attract too much money. It is well-documented that it is easier to do well investing small sums. Once a fund gets bigger, two problems emerge: It is harder to find the same opportunities, and a lot more time has to be devoted to managing a larger, more complex organization -- instead of reading the markets. They are victims of their own success.

Roman Reminders

Third, they believe their own hype. Vanity is one of the greatest human vices. In ancient Rome, generals riding in triumph through the city had a servant standing behind with the task of reminding them of their own mortality. The Romans, as was often the case, were on to something. Too much adoration goes to people’s heads, and makes them do stupid things. That’s just as true of hedge-fund managers as it is of politicians, princes and generals.

Lastly, some of them were just glorified publicity managers. In reality, some of the “stars” were never great in the first place. They were just good at raising their profile. They might well have raised a lot of money from investors. Yet when it came to managing it, they were quickly found out.

The lesson is clear: As soon as a hedge fund acquires any kind of serious publicity, its glory days are over. Some will get too big, others will become obsessed with their own legend.

The bigger they are, the harder they fall.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

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To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net