On the Cash: Are Hedge Fund Proper For You? (February 5, 2025)
At 5 trillion {dollars}, hedge funds have by no means been extra standard — or much less hedged. Buyers have a lot of questions when allocating to this asset class, together with: How a lot capital do you want? What share of your portfolio needs to be allotted? Hiow a lot additonal danger do you assume or keep away from?
The total transcript is under.
~~~
This week’s visitor: Ted Seides is the founder and CIO of Capital Allocators. He discovered about alts working below the legendary David Swensen on the Yale College Investments Workplace. His newest ebook is Personal Fairness Offers: Classes in investing, dealmaking, and operations.
For more information, see:
~~~
Discover the entire earlier On the Cash episodes right here, and within the MiB feed on Apple Podcasts, YouTube, Spotify, and Bloomberg. And discover all the musical playlist of all of the songs I’ve used on On the Cash 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: Enthusiastic about placing some cash into hedge funds? You understand 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 immediately, with forecasts topping 13 trillion globally by 2032. However not all hedge funds are created equally.
Buyers ought to ask themselves. Is that this the correct funding car for me? I’m Barry Ritholtz, and on immediately’s version of On the Cash, We’re going to debate how it is best to take into consideration investing your cash in hedge funds To assist us unpack all of this and what it means in your portfolio. Let’s herald Ted Seides, Ted started his profession below the legendary David Swenson on the Yale College Investments Workplace.
At present, he’s founder and CIO of Capital Allocators and hosts a podcast by the identical title, his ebook, “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 element that would cut back danger.
Barry Ritholtz: And immediately, I believe a whole lot of so known 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 grew to become this very ubiquitous label. And in case you have a look at how the business has advanced immediately. You’ve funds that fall below hedge funds that appear like that authentic premise of equity-like returns. After which you’ve gotten a complete 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 in regards to the prime 2% of fund managers who’re the rock stars. Anybody who places up like actually massive numbers wildly outperforming the market kind of will get feted by the media, after which they kind of fade again into what they had been doing. It appears to create unrealistic expectations amongst a whole lot of buyers. What kind of funding return expectations ought to individuals 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. Individuals do effectively, 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, you realize, 50 p.c a yr with these excessive charges.
Barry Ritholtz: 68%. If I recall, Greg Zuckerman’s ebook on Jim Simons.
Ted Seides: Now, in case you 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 in the meanwhile captures, you realize, 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 believe 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 it as risk-mitigating methods relative to your conventional inventory and bond options.
Barry Ritholtz: So we discuss alpha, which is outperformance over what the market provides you, which is beta. Currently, plainly 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 very 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 definitely been true in hedge funds that, typically talking, for a very long time, Smaller funds have finished higher than bigger funds. Not so positive that’s the case of rising funds, which suggests 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 exceptional job in danger management.
They usually’ve seemingly, in good markets and dangerous, generated that good equity-like anticipated return. There needs to be alpha in that as a result of there’s not a whole lot of beta.
Barry Ritholtz: You mentioned one thing in your ebook 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 put money into a hedge fund, it’s actually vital to grasp how are you desirous about your portfolio and the way do hedge funds slot in. Now, remember, hedge funds can imply a lot of various things and that the methods pursued by one hedge fund goes to look completely totally different from one other one.
So it’s essential perceive, what’s it you’re attempting to perform. Are you attempting to beat the markets together with your hedge fund allocation? Okay, you higher go that takes a whole lot of aggressive danger. Are you attempting to mitigate fairness danger, however get equity-like returns? Okay. You may wish to have a look at a Jones-model hedge fund that has longs and shorts, however has market danger. Or are you attempting to beat the bond markets? You higher go to at least one that doesn’t take fairness danger.
You’ll want to perceive upfront, what’s it you’re attempting to perform by means of that funding after which go search for the answer, not the opposite means round, simply by saying, oh, hedge funds are factor, let me go put money into them.
Barry Ritholtz: That sounds rather a lot like one other phrase I learn within the ebook, an acute consciousness of danger. Ought to buyers be desirous about efficiency first? Ought to they be desirous about danger first? Or are these two sides of the identical coin?
Ted Seides: They’re two sides of the identical coin, however indubitably, buyers needs to be desirous about danger first. And that’s not particular to hedge funds. I might 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 care for themselves. However, the place you actually get tripped up in hedge funds, and there’s an extended 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 effectively. Focus, leverage, and illiquidity. You’ll be able to take any a type of dangers, however in case you take two or definitely 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 share of, uh, capital ought to buyers be desirous about allocating to hedge funds? Whether or not they’re a big establishment or only a high-net-worth household workplace, the place can we go by way of what’s an affordable quantity of danger to take relative to the capital appreciation you’re looking for?
Ted Seides: Should you begin with the standard danger assemble, so let’s say that’s a 70 30 inventory bond or 60/40, say 70/30, the query turns into, outdoors 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 in case you have a look at a number of the most refined establishments, that is likely to be as a lot as 20 p.c 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 whilst a lot as 90%, are non taxable buyers. 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 buyers.
Barry Ritholtz: If you say, non taxable buyers, 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. buyers as effectively.
Barry Ritholtz: All proper. So in case you’re not, you realize, the Yale endowment, however you’re working a pool of cash, how a lot do it’s essential have to consider hedge funds as a substitute in 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 possibly can begin desirous about it. After which what’s a rational share? Is that this a ten p.c shift or is that this one thing kind of?
Ted Seides: I do know for, for me individually, it’s rather a lot 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 will 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, a whole lot 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 keen to absorb the markets?
Barry Ritholtz: And, you realize, because you talked about liquidity, we hear about gates going up now and again, the place a hedge fund will say, “Hey, we’re, we’re, you realize, a little bit tight this quarter and we’re not letting any cash out.” How do you take care of that as an investor?
Ted Seides: It’s important to be very cautious about what the construction of your funding is. So, to take an instance, on the planet of credit score, distressed debt was bucketed in hedge fund methods with quarterly liquidity. But it surely’s not an ideal match for the underlying liquidity of these debt devices.
An increasing number of, these moved into medium-term, say two to five-year funding autos. 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 attempting to guarantee that no matter that hedge fund supervisor is investing in is acceptable for the liquidity that they’re providing.
Barry Ritholtz: Let’s speak a little 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 good monetary disaster, hedge funds have struggled. Some individuals have mentioned, 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 possibly can go earlier than, you realize, 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 accessible 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 grow to be the case that a number of the extra confirmed managers which have demonstrated they will 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 have now heard over the previous 10 years about 1 & 10, 1 & 15, the place are we on the planet of charges?
Ted Seides: You don’t see a whole lot 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 price construction due to the gross return is decrease, the pie is a little bit smaller, it’s essential 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 probably the most half, that type of one and a half and fifteen might be round the place the business 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 price 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 could be completely satisfied 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 satisfied to pay rather a lot for the alpha. On the identical time, there’s of the 5 trillion in belongings, 2 or 3 trillion have existed earlier than individuals began speaking about that.
So that you already had a handshake on what the deal is. These handshakes usually are tough to alter, 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 believe the largest is the place you let off, which is that it’s sensational in any means, form, or kind. In truth, hedge funds, when finished effectively, are fairly darn boring. And that’s most likely the largest false impression.
The opposite is that, you realize, It’s a house that has a whole lot of new exercise. In truth, it’s fairly a mature business at this cut-off date. 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. If you’d like some pleasure, take 800 bucks and go to Vegas.” There positively is a few, some fact to that.
Last query which is a quote of yours from the ebook: “The ability of capital allocation lies not to find funding, however in figuring out the one that matches greatest with the allocator’s technique and constraints.” Talk about that.
Ted Seides:We talked about a little bit earlier, no funding suits Each investor the identical means and so sure, it does matter to attempt to discover say an ideal hedge fund on this instance If that’s gonna match together with your portfolio, however what’s extra vital is knowing What are your targets and may these kind of methods assist obtain your targets?
Barry Ritholtz: To sum up, you probably have a long run perspective and also you’re not awed by a number of the massive names and rock stars who often put up spectacular numbers, and also you’re sitting on sufficient capital that you may allocate 5 p.c or 10 p.c to a fund that is likely to be a little bit riskier and have a little bit increased tax results, however concurrently may 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 pay attention to the truth that the most effective funds might not be open to you and you could not have sufficient capital to place cash in them. However in case you’re sitting on sufficient money and you probably have recognized a fund that’s match together 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
