Why Investors Shouldn’t Bother With Hedge Funds Anymore

They call Wall Street’s big hedge fund managers the “Masters of the Universe,” the ultra-wealthy, extremely powerful, undisputed lords of finance who seem to exist in a gilt world that consists solely of London W1, the Upper East Side of Manhattan, and Greenwich, Connecticut.

But… all is not well in the ivory tower. The “Masters of the Universe” just might be an endangered species.

The financial media has been pumping out stories about struggling funds, disgraced managers, and fleeing investors, all quoting high-profile critics of hedge funds. Even the old Occupy Wall Street gang, jarred by the media from their long nap, is back with a new movement: “Hedge Clippers.”

That’s not just noise. There’s a good reason for the growing widespread discontent with the antics of Wall Street’s legendary “hedgies.” Investor patience is running out.

But luckily for us, the hedge funds’ fall from heaven is likely to be a godsend to independent investors.

But first, a full disclosure: I used to be a hedge fund manager, so I’ve got an insider’s view on what’s happening here, and it’s going to be big.

What a Hedge Fund Is (and What It Isn’t)

For as much mystique as hedge funds and their managers command, plenty of folks don’t quite have the whole picture.

One of the biggest misconceptions is that hedge funds, well, hedge. The truth is, hardly any funds hedge their positions anymore… as evidenced by the fact that the Barclay Hedge Fund Index shows these funds have returned a measly 0.22% on average in 2016.

Hedge fund has simply become the generic name for a fund, usually structured as a limited partnership, where the general partner manages money put in by limited partners, and pooled capital is invested based on the general partner’s investment strategy.

A hedge fund can be an investment vehicle that invests in stocks, bonds, commodities, all three, or in mortgages, or derivatives, or foreign currencies, or bets on foreign stocks, or real estate, or art, or just about anything that investors believe a manager can make money investing in. And some hedge funds actually try and hedge.

Then there are the fees… the infamous “2 & 20.”

Because fund managers boast they can make huge sums of money with their strategies, and investors expect them to, they charge limited partners a management fee and a performance fee.

A management fee, typically 2%, is a flat fee managers charge just to handle investors’ money. Regardless of whether the manager makes or loses money, investors pay 2% of the money they have in the fund.

While a 2% annual management fee is good money, it’s chickenfeed to hedge fund managers.

Hedge fund managers are in business to make performance fees. A performance fee, typically 20%, is what the manager takes off the top of profits he makes to pay himself for his good work.

That’s why managers or funds that charge these fees are sometimes called “2 & 20 managers,” or “2 & 20 funds.”

It’s the “2 & 20” cost to be in hedge funds that everyone’s bashing these days.

Investors don’t mind the exorbitant fees if managers deliver rich, market-beating returns.