On the Cash: Are Hedge Fund Proper For You? (February 5, 2025)
At 5 trillion {dollars}, hedge funds have by no means been extra fashionable — or much less hedged. Traders have plenty of questions when allocating to this asset class, together with: How a lot capital do you want? What proportion of your portfolio needs to be allotted? Hiow a lot additonal danger do you assume or keep away from?
The complete transcript is beneath.
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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 guide is Non-public Fairness Offers: Classes in investing, dealmaking, and operations.
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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: Fascinated 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 house to swell to over 5 trillion in belongings at the moment, 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 best funding automobile for me? I’m Barry Ritholtz, and on at the moment’s version of On the Cash, We’re going to debate how it’s best to 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.
In the present day, he’s founder and CIO of Capital Allocators and hosts a podcast by the identical title, his guide, “So You Need to Begin a Hedge Fund, Classes for Managers and Allocators” is the seminal work within the house. 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 danger than the fairness markets.
So actually hedged funds, a fund that had some hedging part that would cut back danger.
Barry Ritholtz: And at the moment, I feel loads of so known as hedge funds are usually 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 when you take a look at how the trade has developed at the moment. You’ve gotten funds that fall beneath hedge funds that appear like that unique premise of equity-like returns. After which you have got an entire different set that look extra like bond-like returns. And totally different methods can match into these two totally different groupings.
Barry Ritholtz: I discussed within the introduction, we at all times appear to listen to concerning the prime 2% of fund managers who’re the rock stars. Anybody who places up like actually massive 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 loads of traders. What kind of funding return expectations ought to folks investing in hedge funds have?
Ted Seides: These expectations needs to be extra modest than what you may count on. 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 positively, the information sensationalizes nice efficiency and awful efficiency.
What you may learn within the press is these unimaginable Renaissance Medallion, , 50 p.c a yr with these excessive charges.
Barry Ritholtz: 68%. If I recall, Greg Zuckerman’s guide on Jim Simons.
Ted Seides: Now, when you checked out hedge funds as an entire 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%. Many of the motion isn’t on both tail. Many 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 in the intervening time captures, , the general public’s fancy after which on to the following? That’s not how the professionals actually take into consideration the house, 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 might be on the tails, um, however it’s not how hedge funds are invested in by those that have their cash in danger. They’re actually taking a look at 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. Recently, it appears that evidently alpha comes from two locations: Rising managers — the brand new fund managers who sort of establish market inefficiency; and the quants who’ve appeared to be doing rather well as of late. What do you concentrate on these two sub sectors inside the hedge fund house?
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 accomplished higher than bigger funds. Not so positive 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.
They usually’ve seemingly, in good markets and unhealthy, generated that good equity-like anticipated return. There must be alpha in that as a result of there’s not loads of beta.
Barry Ritholtz: You stated one thing in your guide 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 resolve, I wish to spend money on a hedge fund, it’s actually vital to know how are you enthusiastic about your portfolio and the way do hedge funds slot in. Now, bear in mind, hedge funds can imply plenty of various things and that the methods pursued by one hedge fund goes to look completely totally different from one other one.
So you could 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 loads of aggressive danger. Are you making an attempt to mitigate fairness danger, however get equity-like returns? Okay. You may wish to take a look at a Jones-model hedge fund that has longs and shorts, however has market danger. Or are you making an attempt to beat the bond markets? You higher go to at least one that doesn’t take fairness danger.
You want to perceive upfront, what’s it you’re making an attempt to perform by that funding after which go search for the answer, not the opposite method round, simply by saying, oh, hedge funds are an excellent factor, let me go spend money on them.
Barry Ritholtz: That sounds quite a bit like one other phrase I learn within the guide, an acute consciousness of danger. Ought to traders be enthusiastic about efficiency first? Ought to they be enthusiastic about danger first? Or are these two sides of the identical coin?
Ted Seides: They’re two sides of the identical coin, however surely, traders needs to be enthusiastic about danger first. And that’s not particular to hedge funds. I’d argue that’s true in all of investing.
When you perceive the chance you’re taking and also you search for some kind 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 danger 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 yr, this was a wipeout. How can an investor consider these dangers upfront?
Ted Seides: Properly, there are three pillars that don’t go collectively nicely. Focus, leverage, and illiquidity. You’ll be able to take any a kind of dangers, however when you take two or actually three on the identical time, that’s a recipe for catastrophe.
Barry Ritholtz: Your podcast known as Capital Allocators, results in the plain query, what proportion of, uh, capital ought to traders be enthusiastic about 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 when it comes to what’s an affordable quantity of danger to take relative to the capital appreciation you’re looking for?
Ted Seides: When you begin with the normal danger 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 wish to say, okay, I need equity-like hedge funds. And when you take a look at a number of the most subtle establishments, that is likely to be as a lot as 20 p.c of their portfolio. The largest 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 whilst a lot as 90%, are non taxable traders. There are just some hedge fund methods, they usually are usually issues like activism which have longer length funding holding durations, that make sense for taxable traders.
Barry Ritholtz: While you say, non taxable traders, I’m considering of foundations, endowments. Massive, 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 when you’re not, , the Yale endowment, however you’re operating a pool of cash, how a lot do you could have to consider hedge funds in its place on your portfolio?
Ted Seides: You’re most likely within the double-digit thousands and thousands earlier than it even is sensible to consider it
Barry Ritholtz: 10 million and up and you would begin enthusiastic about it. After which what’s a rational proportion? Is that this a ten p.c shift or is that this one thing roughly?
Ted Seides: I do know for, for me individually, it’s quite a bit lower than it was once I was managing capital for establishments. So for me individually, it’s about 5 p.c 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 danger is a part of it. Is that the unholy trifecta that retains you at 5%?
Ted Seides: Relying on the technique, loads of hedge fund methods have quarterly liquidity, so it’s not every day, however they’re comparatively liquid.
However for positive, Taxes matter, after which it’s simply danger, like how a lot danger are you prepared to absorb the markets?
Barry Ritholtz: And, , because you talked about liquidity, we hear about gates going up from time to time, the place a hedge fund will say, “Hey, we’re, we’re, , a bit tight this quarter and we’re not letting any cash out.” How do you cope with that as an investor?
Ted Seides: You must be very cautious about what the construction of your funding is. So, to take an instance, on the earth 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 acceptable 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 suitable for the liquidity that they’re providing.
Barry Ritholtz: Let’s speak a bit bit about efficiency earlier than the monetary disaster, It appeared that each hedge fund was simply killing it and, and printing cash. Following the nice monetary disaster, hedge funds have struggled. Some folks have stated, you solely wish to be within the prime decile or two. What are your ideas on, on who’s producing alpha and the way far down, um, the, the road you would go earlier than, , 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 positive, 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 tougher to, to extract these returns. So I do assume it’s turn out to be the case that a number of 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 house.
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 now have heard over the previous 10 years about 1 & 10, 1 & 15, the place are we on the earth of charges?
Ted Seides: You don’t see loads 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 payment construction due to the gross return is decrease, the pie is a bit smaller, you could take a smaller slice of that pie.
The exceptions to that, after all, are the managers who’ve continued to ship. And in some cases, you really see charges going up.
Barry Ritholtz: 3 & 30?
Ted Seides: You’ve seen D.E Shaw raised their charges a yr or two in the past. However for essentially the most half, that sort 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 direction of Pivot charges or beta plus, which was, Hey, we’re going to cost you a really modest payment 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: Many of the establishments could be completely happy to pay excessive charges for true alpha. There are at all times efforts to attempt to determine how do you separate the alpha from the beta, how can we pay not a lot for the beta, and completely happy to pay quite a bit for the alpha. On the identical 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 usually are tough to vary, however for positive in new buildings, when new capital will get allotted, you do see that try to actually isolate paying for efficiency
Barry Ritholtz: What are a number of the greatest misconceptions about investing within the hedge fund house?
Ted Seides: I feel the largest is the place you let off, which is that it’s sensational in any method, form, or type. The truth is, hedge funds, when accomplished nicely, are fairly darn boring. And that’s most likely the largest false impression.
The opposite is that, , It’s a house that has loads of new exercise. The truth is, it’s fairly a mature trade at this time limit. And many of the capital is being managed by the corporations who’ve been round for a very long time.
Barry Ritholtz: You’re reminding me of the well-known Paul Samuelson quote, “Good investing needs to be like watching paint dry or grass develop. In order for you some pleasure, take 800 bucks and go to Vegas.” There undoubtedly is a few, some reality to that.
Ultimate query which is a quote of yours from the guide: “The ability of capital allocation lies not to find an excellent funding, however in figuring out the one that matches finest with the allocator’s technique and constraints.” Talk about that.
Ted Seides:We talked about a bit earlier, no funding suits Each investor the identical method 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 objectives and might these kind of methods assist obtain your objectives?
Barry Ritholtz: To sum up, when you have a long run perspective and also you’re not awed by a number of the massive names and rock stars who sometimes put up spectacular numbers, and also you’re sitting on sufficient capital that you could allocate 5 p.c or 10 p.c to a fund that is likely to be a bit riskier and have a bit greater tax results, however concurrently might diversify your returns and will generate higher than anticipated returns, you may wish to take into consideration this house.
You actually wish to assume carefully about your technique and your liquidity necessities and concentrate on the truth that the very best funds will not be open to you and you might not have sufficient capital to place cash in them. However when you’re sitting on sufficient money and when you have recognized a fund that’s an excellent match along with your technique and your danger tolerance, there are some benefits to hedge fund investing that you simply 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
