At the Money: Are Hedge Fund Right For You? (February 5, 2025)
At 5 trillion {dollars}, hedge funds have by no means been extra fashionable — or much less hedged. Traders have numerous questions when allocating to this asset class, together with: How a lot capital do you want? What proportion of your portfolio must be allotted? Hiow a lot additonal threat do you assume or keep away from?
The total transcript is below.
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This week’s visitor: Ted Seides is the founder and CIO of Capital Allocators. He discovered about alts working beneath the legendary David Swensen on the Yale College Investments Workplace. His newest e-book is Non-public Fairness Offers: Classes in investing, dealmaking, and operations.
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Discover the entire earlier On the Cash episodes here, and within the MiB feed on Apple Podcasts, YouTube, Spotify, and Bloomberg. And discover your complete musical playlist of all of the songs I’ve used on At the Money on Spotify
TRANSCRIPT:
Ted Seides: Are Hedge Fund Proper For You?
Musical Intro:
Go on, take the cash and runGo on, take the cash and runHoo-hoo-hooGo on, take the cash and runGo on, take the cash and run
Barry Ritholtz: Eager about placing some cash into hedge funds? You recognize all of the rockstar names who produce eye popping returns. Chasing that efficiency has led the hedge fund area to swell to over 5 trillion in belongings immediately, with forecasts topping 13 trillion globally by 2032. However not all hedge funds are created equally.
Traders ought to ask themselves. Is that this the precise funding car for me? I’m Barry Ritholtz, and on immediately’s version of On the Cash, We’re going to debate how you must take into consideration investing your cash in hedge funds To assist us unpack all of this and what it means on your portfolio. Let’s herald Ted Seides, Ted started his profession beneath the legendary David Swenson on the Yale College Investments Workplace.
Right now, he’s founder and CIO of Capital Allocators and hosts a podcast by the identical title, his e-book, “So You Wish to Begin a Hedge Fund, Classes for Managers and Allocators” is the seminal work within the area. So Ted, let’s begin out with the fundamentals. Why hedge funds? What’s the enchantment?
Ted Seides: The unique premise of hedge funds was to ship an equity-like return in marketable securities with much less threat than the fairness markets.
So actually hedged funds, a fund that had some hedging part that would cut back threat.
Barry Ritholtz: And immediately, I feel lots of so referred to as hedge funds should not precisely hedged. They appear to be falling into all kinds of various silos.
Ted Seides: Hedge fund as a time period turned this very ubiquitous label. And if you happen to have a look at how the trade has advanced immediately. You might have funds that fall beneath hedge funds that appear like that authentic premise of equity-like returns. After which you will have a complete different set that look extra like bond-like returns. And completely different methods can match into these two completely different groupings.
Barry Ritholtz: I discussed within the introduction, we all the time appear to listen to concerning the high 2% of fund managers who’re the rock stars. Anybody who places up like actually large numbers wildly outperforming the market type of will get feted by the media, after which they type of fade again into what they had been doing. It appears to create unrealistic expectations amongst lots of traders. What kind of funding return expectations ought to folks investing in hedge funds have?
Ted Seides: These expectations must be extra modest than what you may anticipate. learn within the press. Barry, what you simply described describes markets. Folks do nicely, they revert to the imply. It occurs in each technique. And definitely, the information sensationalizes nice efficiency and awful efficiency.
What you may learn within the press is these unimaginable Renaissance Medallion, you recognize, 50 % a 12 months with these excessive charges.
Barry Ritholtz: 68%. If I recall, Greg Zuckerman’s e-book on Jim Simons.
Ted Seides: Now, if you happen to checked out hedge funds as a complete and attempt to get at, let’s say, that fairness like anticipated return, you’re speaking about like a excessive single digits quantity. Has nothing to do with 68%. A lot of the motion isn’t on both tail. A lot of the motion’s proper within the center.
Barry Ritholtz: That appears to be very opposite to how we learn and listen to about hedge funds within the media. Is it that whoever’s scorching for the time being captures, you recognize, the general public’s fancy after which on to the following? That’s not how the professionals actually take into consideration the area, is it?
Ted Seides: That’s proper. I feel that’s typically how the media works at investing, proper? The information tales. are the issues which are on the tails, um, but it surely’s not how hedge funds are invested in by those that have their cash in danger. They’re actually it as risk-mitigating methods relative to your conventional inventory and bond alternate options.
Barry Ritholtz: So we discuss alpha, which is outperformance over what the market provides you, which is beta. Currently, evidently alpha comes from two locations: Rising managers — the brand new fund managers who type of determine market inefficiency; and the quants who’ve appeared to be doing rather well as of late. What do you consider these two sub sectors throughout the hedge fund area?
Ted Seides: In all of asset administration, there’s this aphorism, measurement is the enemy of efficiency. And it’s actually been true in hedge funds that, typically talking, for a very long time, Smaller funds have executed higher than bigger funds. Not so certain that’s the case of rising funds, which implies new, however on measurement you, you get that.
Now what’s an fascinating dynamic and it will get into the quant is increasingly more cash has been sucked in by these so-called platform hedge funds: Citadel, Millennium, Point72, locations like that, the place have, they’ve a number of portfolio managers and do an outstanding job in danger management.
And so they’ve seemingly, in good markets and dangerous, generated that good equity-like anticipated return. There must be alpha in that as a result of there’s not lots of beta.
Barry Ritholtz: You mentioned one thing in your e-book that resonated with me. The perfect allocators set up clear processes for evaluating alternatives and setting priorities. Clarify what you imply by that.
Ted Seides: Properly, earlier than you simply determine, I need to spend money on a hedge fund, it’s actually vital to know how are you fascinated by your portfolio and the way do hedge funds slot in. Now, bear in mind, hedge funds can imply numerous various things and that the methods pursued by one hedge fund goes to look completely completely different from one other one.
So that you must perceive, what’s it you’re making an attempt to perform. Are you making an attempt to beat the markets along with your hedge fund allocation? Okay, you higher go that takes lots of aggressive threat. Are you making an attempt to mitigate fairness threat, however get equity-like returns? Okay. You may need to have a look at a Jones-model hedge fund that has longs and shorts, however has market threat. Or are you making an attempt to beat the bond markets? You higher go to 1 that doesn’t take fairness threat.
It’s essential to perceive prematurely, what’s it you’re making an attempt to perform by way of that funding after which go search for the answer, not the opposite approach round, simply by saying, oh, hedge funds are a very good factor, let me go spend money on them.
Barry Ritholtz: That sounds loads like one other phrase I learn within the e-book, an acute consciousness of threat. Ought to traders be fascinated by efficiency first? Ought to they be fascinated by threat first? Or are these two sides of the identical coin?
Ted Seides: They’re two sides of the identical coin, however indubitably, traders must be fascinated by threat first. And that’s not particular to hedge funds. I’d argue that’s true in all of investing.
Should you perceive the chance you’re taking and also you search for some sort of asymmetry or convexity, the rewards can handle themselves. However, the place you actually get tripped up in hedge funds, and there’s a protracted historical past of this, going again to long run capital in 1998, is when threat will get uncontrolled.
Barry Ritholtz: Long run capital administration very famously blew up when Russia defaulted on their bonds. They had been leveraged so this wasn’t like a nasty 12 months, this was a wipeout. How can an investor consider these dangers prematurely?
Ted Seides: Properly, there are three pillars that don’t go collectively nicely. Focus, leverage, and illiquidity. You may take any a type of dangers, however if you happen to take two or actually three on the similar time, that’s a recipe for catastrophe.
Barry Ritholtz: Your podcast known as Capital Allocators, results in the apparent query, what proportion of, uh, capital ought to traders be fascinated by allocating to hedge funds? Whether or not they’re a big establishment or only a high-net-worth household workplace, the place will we go by way of what’s an affordable quantity of threat to take relative to the capital appreciation you’re searching for?
Ted Seides: Should you begin with the standard threat assemble, so let’s say that’s a 70 30 inventory bond or 60/40, say 70/30, the query turns into, exterior of your shares and bonds, the place do the place are you able to get diversification?
And also you may need to say, okay, I need equity-like hedge funds. And if you happen to have a look at among the most subtle establishments, that is perhaps as a lot as 20 % of their portfolio. The most important distinction for these establishments and high-net-worth people is taxes. Most hedge fund methods are tax-inefficient.
In order that Of that 5 trillion, the overwhelming majority of it, possibly at the same time as a lot as 90%, are non taxable traders. There are just some hedge fund methods, and so they are typically issues like activism which have longer period funding holding intervals, that make sense for taxable traders.
Barry Ritholtz: Whenever you say, non taxable traders, I’m pondering of foundations, endowments. Giant, not even tax deferred, simply tax exempt entities that may put that cash to work with out worrying about Uncle Sam? Is that, is that proper?
Ted Seides: That’s proper. They’ve pension funds, non U. S. traders as nicely.
Barry Ritholtz: All proper. So if you happen to’re not, you recognize, the Yale endowment, however you’re operating a pool of cash, how a lot do that you must have to consider hedge funds instead on your portfolio?
Ted Seides: You’re most likely within the double-digit tens of millions earlier than it even is smart to consider it
Barry Ritholtz: 10 million and up and you might begin fascinated by it. After which what’s a rational proportion? Is that this a ten % shift or is that this one thing roughly?
Ted Seides: I do know for, for me individually, it’s loads lower than it was after I was managing capital for establishments. So for me individually, it’s about 5 % as a result of I must really feel just like the managers are so good that they’ll make up for that tax drawback.
Barry Ritholtz: Taxes are a part of it, illiquidity is a part of it, and threat is a part of it. Is that the unholy trifecta that retains you at 5%?
Ted Seides: Relying on the technique, lots of hedge fund methods have quarterly liquidity, so it’s not day by day, however they’re comparatively liquid.
However for certain, Taxes matter, after which it’s simply threat, like how a lot threat are you prepared to absorb the markets?
Barry Ritholtz: And, you recognize, because you talked about liquidity, we hear about gates going up every so often, the place a hedge fund will say, “Hey, we’re, we’re, you recognize, slightly tight this quarter and we’re not letting any cash out.” How do you cope with that as an investor?
Ted Seides: You need to be very cautious about what the construction of your funding is. So, to take an instance, on this planet of credit score, distressed debt was once bucketed in hedge fund methods with quarterly liquidity. But it surely’s not an important match for the underlying liquidity of these debt devices.
An increasing number of, these moved into medium-term, say two to five-year funding automobiles. And now you see rather more of that within the personal credit score world that has an asset-liability match. It’s rather more applicable for the underlying belongings. So it’s much less what the liquidity is and making an attempt to be sure that no matter that hedge fund supervisor is investing in is acceptable for the liquidity that they’re providing.
Barry Ritholtz: Let’s discuss slightly bit about efficiency earlier than the monetary disaster, It appeared that each hedge fund was simply killing it and, and printing cash. Following the good monetary disaster, hedge funds have struggled. Some folks have mentioned, you solely need to be within the high decile or two. What are your ideas on, on who’s producing alpha and the way far down, um, the, the road you might go earlier than, you recognize, you’re within the backside half of the efficiency observe.
Ted Seides: Over these final 15 years. the world has gotten much more aggressive. So for certain, no matter pool of alpha was obtainable earlier than the monetary disaster, if it’s the identical pool, it’s, there are much more {dollars} pursuing it, and it’s been a lot more durable to, to extract these returns. So I do assume it’s turn out to be the case that among the extra confirmed managers which have demonstrated they’ll generate extra returns are those who’ve commanded extra {dollars}.
So that you’ve seen an elevated focus of the belongings going to sure managers within the hedge fund area.
Barry Ritholtz: Let’s discuss charges. 2 and 20 has been the well-known quantity for hedge funds for a very long time. Though, we have now heard over the previous 10 years about 1 & 10, 1 & 15, the place are we on this planet of charges?
Ted Seides: You don’t see lots of 2 & 20. And a part of that’s that charges are simply decided by provide and demand. Consider it as a clearing value for provide and demand. So when returns typically have come down, these methods don’t actually command as excessive a charge construction due to the gross return is decrease, the pie is slightly smaller, that you must take a smaller slice of that pie.
The exceptions to that, after all, are the managers who’ve continued to ship. And in some situations, you truly see charges going up.
Barry Ritholtz: 3 & 30?
Ted Seides: You’ve seen D.E Shaw raised their charges a 12 months or two in the past. However for probably the most half, that type of one and a half and fifteen might be round the place the trade is.
Barry Ritholtz: There was a motion a few years in the past in the direction of Pivot charges or beta plus, which was, Hey, we’re going to cost you a really modest charge and also you’re going to pay us solely on our outperformance over the market. What, what occurred with that motion? Did that achieve any traction or, or the place are we with that?
Ted Seides: A lot of the establishments can be blissful to pay excessive charges for true alpha. There are all the time efforts to strive to determine how do you separate the alpha from the beta, how can we pay not a lot for the beta, and blissful to pay loads for the alpha. On the similar time, there’s of the 5 trillion in belongings, 2 or 3 trillion have existed earlier than folks began speaking about that.
So that you already had a handshake on what the deal is. These handshakes typically are troublesome to vary, however for certain in new constructions, when new capital will get allotted, you do see that try to actually isolate paying for efficiency
Barry Ritholtz: What are among the greatest misconceptions about investing within the hedge fund area?
Ted Seides: I feel the largest is the place you let off, which is that it’s sensational in any approach, form, or kind. In reality, hedge funds, when executed nicely, are fairly darn boring. And that’s most likely the largest false impression.
The opposite is that, you recognize, It’s a area that has lots of new exercise. In reality, it’s fairly a mature trade at this time limit. And many of the capital is being managed by the companies who’ve been round for a very long time.
Barry Ritholtz: You’re reminding me of the well-known Paul Samuelson quote, “Good investing must be like watching paint dry or grass develop. If you need some pleasure, take 800 bucks and go to Vegas.” There positively is a few, some fact to that.
Ultimate query which is a quote of yours from the e-book: “The talent of capital allocation lies not to find a very good funding, however in figuring out the one that matches greatest with the allocator’s technique and constraints.” Focus on that.
Ted Seides:We talked about slightly earlier, no funding matches Each investor the identical approach and so sure, it does matter to attempt to discover say an important hedge fund on this instance If that’s gonna match along with your portfolio, however what’s extra vital is knowing What are your targets and might these kind of methods assist obtain your targets?
Barry Ritholtz: To sum up, if in case you have a long run perspective and also you’re not awed by among the large names and rock stars who often put up spectacular numbers, and also you’re sitting on sufficient capital that you may allocate 5 % or 10 % to a fund that is perhaps slightly riskier and have slightly greater tax results, however concurrently may diversify your returns and will generate higher than anticipated returns, you may need to take into consideration this area.
You actually need to assume intently about your technique and your liquidity necessities and pay attention to the truth that the most effective funds might not be open to you and it’s possible you’ll not have sufficient capital to place cash in them. However if you happen to’re sitting on sufficient money and if in case you have recognized a fund that’s a very good match along with your technique and your threat tolerance, there are some benefits to hedge fund investing that you just don’t get from conventional 60/40 portfolios.
I’m Barry Ritholtz. You’re listening to Bloomberg’s At The Cash.
Musical fade out:
Go on, take the cash and runGo on, take the cash and runHoo-hoo-hooGo on, take the cash and runGo on, take the cash and run
