Economy & Budget

The New Investment Strategy Turbocharging Hedge Funds’ Returns

It has been a tough time to be a hedge-fund manager over the past decade.

Hedge funds have lagged the S&P 500 substantially since 2006. The HFRI Index, a broad measure of hedge-fund performance, returned just 3.4% per annum since 2006. That’s 3% behind the S&P 500’s annual performance.

So what’s the source of this underperformance? I think it comes down to information.

You have more information in your pocket on your smartphone than top hedge funds had 15 years ago.

With $3 trillion of hedge-fund assets chasing opportunities, much of hedge funds’ informational “edge” has just disappeared. Strategies that worked yesterday are competed away with blinding quickness. Once identified, these strategies cede their secrets to computer algorithms that wring out every last bit of profit from financial markets.

This underperformance has put hedge funds in a bind. How can they justify charging exorbitant costs if they fail to show investors the money?

Even some of the hedge-fund industry’s founding fathers like Paul Tudor Jones have been forced to reduce their fees.

Private Equity: a New ‘Edge’

Private equity is a close cousin of hedge funds.

Private-equity investors will often buy an entire company, invest vast amounts of time and money turn it around and then sell it or list it on a stock exchange.

Unlike hedge funds, private-equity investors have made money consistently over the past decade.

No wonder some hedge funds are joining the private-equity party. Instead of making small speculative bets on stocks, a handful of hedge funds are placing big bets on private-equity-style transactions to boost their flagging returns.

Hedge funds provide the funds to finance company buyouts.

Private equity investors then do the hard work of slashing and burning companies to wring out profits.

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