The Billion Dollar Club

Some data on where the hedge fund assets under management are currently held within the “industry” via CIO Magazine (emphasis mine):

the top 11% of managers controlled 92%—or $2.78 trillion—of total hedge fund assets at the end of Q1 2015. These 570 managers also each held at least $1 billion in assets, qualifying their membership of the “$1 billion club”.

Of these top firms, more than 400 managing $1 billion to $4.9 billion collectively controlled $892 billion while 22 managers with $20 billion or more, had $790 billion all together, the report said.

Older managers with a “consistently strong track record over many market cycles” were prominently featured in the $1 billion club, Preqin found. On average, managers with more than $20 billion were established in 1992.

If you founded a hedge fund in the early 1990’s, you probably had 100 serious competitors in chasing down the alpha that used to be the lifeblood of the hedge fund game. Cramer was running like a hundred million and he was considered to be a big dog back then. There was little competition for great analysts and PMs because there just weren’t as many funds. And there was no Reg FD meaning information was disseminated in advance to a small handful of players, who would then sell it to the “club” while everyone else got it later, if ever. And I won’t even get started on the free-money sweepstakes of the 90’s IPO era and what automatic, guaranteed flip profits probably meant to returns when all of the funds were so small.

Today, many of the 1980’s and 1990’s-vintage fund companies are still making hay off of their returns from the old days, when outsized returns were easier (but still hard) to achieve and alpha was everywhere you looked. If you compounded at 20% for a decade and then just delivered a market return for the second decade, your time-weighted returns still look outstanding. Never mind that you had a tenth of the money under management during that initial 10-year period.

The track record is great, so long as no one pays any attention to your fund’s dollar-weighted returns.

Thankfully, no one knows to even ask about dollar-weighted returns (which adjust the fund’s performance based on how much was invested and when – thus giving you a real picture of how much was actually made). The people who do understand this concept (fund of funds, packagers, wealth managers) don’t actually want to see that information. Having a shred of doubt in one’s mind really fucks up the sales pitch.

Every year there will be superstar hedge fund managers. Some of them will continue to be superstars year after year. You will know them because they’ll be the ones who can’t wait to return your money back to you and keep you from sending more. For the rest of the field of large hedge funds, the more they can incorporate their 1990’s and 2000’s performance records into the marketing, the better.

Barring some sort of extreme event where the best traders on earth are abducted by flying saucers while all of the top hedge funds instantly have their assets cut in half – a return to the 1985-2005 era of sustained, bountiful, uncorrelated outperformance for everyone is highly unlikely. Investors should ask themselves if the returns from La Belle Époque are likely to be a meaningful track record given the competitive dynamics of the current era.

Because it’s not that hedge fund managers are unskilled – it’s that way too many of them are so highly skilled. This is why alpha is so hard to come by. Especially the heaping amounts of alpha that are worth paying 20% of the gains for.