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The Hedge Fund Way: Pay More, to Get Less, and Be Unable to Access Your Money

Date: Monday, December 9, 2013
Author: Nick Summers, Bloomberg Businessweek

Another month, another marker that hedge funds are having an annus horribilis: With returns of 7.1 percent so far this year, the industry is badly trailing the broader market, where the Standard & Poor’s 500-stock index has gained 29.1 percent. If the pace continues, 2013 will be the worst year for the asset class, compared with stocks, in nearly a decade. Hedge fund manager Stanley Druckenmiller called the results a “tragedy” on Bloomberg TV on Nov. 22.

Bloomberg Businessweek’s Sheelah Kolhatkar noted similarly bleak figures earlier this week, and highlighted a Goldman Sachs (GS) report showing that hedge funds are mostly wagering that stocks will rise—through big bets on big names like AIG, Apple, Google, General Motors, and Citigroup (C). That lumps them in with the investing fate of the broader market, the so-called “dumb money” that hedge funds are supposed to be able to outwit. The fees that hedgies charge their clients—typically 2 percent of assets and 20 percent of returns, sometimes higher—further eat into lackluster gains.

You could say that harping on underperformance is beating a dead horse, but this is a horse that’s far from dead. The hedge fund industry has $2.8 trillion under management, according to research firm EVestment. Newly loosened regulations will allow hedge funds to advertise to the wider public, after 80 years of being restricted to “accredited” investors with six-figure sums to invest.

Josh Brown, an investment adviser and trenchant financial blogger, posted a letter this morning from an unnamed reader who invests institutions’ money. While the bottom-line struggles of hedge funds are becoming better known, this reader pointed out a number of smaller reasons hedge funds can be a disaster for individuals and institutions alike. First: abrupt closures. “Hedge funds can close because of the loss of large investors, untimely investments or simply bored managers that have more than enough money and are sick of meeting client expectations,” Brown’s reader writes.

More worryingly, it can be difficult to get money out of a hedge fund. While contributions can usually be made on a monthly basis, withdrawals often face quarterly limits—and in the case of a full redemption, there’s often something called “holdback,” in which the fund retains 10 percent to 20 percent of assets until its annual audit is completed. “So you are forced to sit and wait as your money earns nothing while they make sure the NAV is correct,” Brown’s reader writes. “Contrast this with index funds and ETFs that are priced every second of the trading day.”

You might think that trailing the broader stock market and insisting on client-hostile rules would chasten the hedge fund industry. You would be wrong. Compensation in the field increased for the third straight year in 2013, according to Opalesque, a financial news outlet, with “average compensation at a mid-performing fund totaling $353,000.” Average pay for a portfolio manager at a large fund? $2.2 million.