On the Cash: Are Hedge Fund Proper For You? (February 5, 2025)
At 5 trillion {dollars}, hedge funds have by no means been extra widespread — or much less hedged. Traders 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 threat do you assume or keep away from?
The total transcript is under.
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This week’s visitor: Ted Seides is the founder and CIO of Capital Allocators. He realized 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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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 by 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 area to swell to over 5 trillion in property as we speak, 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 fitting funding automobile for me? I’m Barry Ritholtz, and on as we speak’s version of On the Cash, We’re going to debate how you need 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 beneath 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 e book, “So You Need 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 attraction?
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 scale back threat.
Barry Ritholtz: And as we speak, I believe numerous so referred to as hedge funds aren’t precisely hedged. They appear to be falling into all types 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 as we speak. You will have funds that fall beneath hedge funds that appear to be that unique premise of equity-like returns. After which you may 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 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 form of will get feted by the media, after which they form of fade again into what they have been doing. It appears to create unrealistic expectations amongst numerous 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 would possibly count on. learn within the press. Barry, what you simply described describes markets. Folks do properly, they revert to the imply. It occurs in each technique. And positively, the information sensationalizes nice efficiency and awful efficiency.
What you would possibly learn within the press is these unbelievable 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, when 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 intervening time captures, you recognize, the general public’s fancy after which on to the subsequent? That’s not how the professionals actually take into consideration the area, is it?
Ted Seides: That’s proper. I believe that’s usually how the media works at investing, proper? The information tales. are the issues which are on the tails, um, nevertheless 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 alternate options.
Barry Ritholtz: So we discuss alpha, which is outperformance over what the market provides you, which is beta. Currently, 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 gave the impression 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, usually talking, for a very long time, Smaller funds have performed 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 attention-grabbing dynamic and it will get into the quant is increasingly 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 unhealthy, generated that good equity-like anticipated return. There must be alpha in that as a result of there’s not numerous beta.
Barry Ritholtz: You mentioned one thing in your e book that resonated with me. One of the best allocators set up clear processes for evaluating alternatives and setting priorities. Clarify what you imply by that.
Ted Seides: Effectively, earlier than you simply determine, I wish to spend money on a hedge fund, it’s actually necessary to know how are you interested by 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 completely different from one other one.
So it’s worthwhile to perceive, what’s it you’re making an attempt to perform. Are you making an attempt to beat the markets together with your hedge fund allocation? Okay, you higher go that takes numerous aggressive threat. Are you making an attempt to mitigate fairness threat, however get equity-like returns? Okay. You would possibly wish to take 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 worthwhile to perceive prematurely, what’s it you’re making an attempt to perform via that funding after which go search for the answer, not the opposite manner round, simply by saying, oh, hedge funds are factor, let me go spend money on them.
Barry Ritholtz: That sounds so much like one other phrase I learn within the e book, an acute consciousness of threat. Ought to traders be interested by efficiency first? Ought to they be interested by threat first? Or are these two sides of the identical coin?
Ted Seides: They’re two sides of the identical coin, however definitely, traders needs to be interested 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 maintain 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 threat will get uncontrolled.
Barry Ritholtz: Long run capital administration very famously blew up when Russia defaulted on their bonds. They have 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: Effectively, there are three pillars that don’t go collectively properly. Focus, leverage, and illiquidity. You may take any a kind of dangers, however when you take two or actually three on the similar time, that’s a recipe for catastrophe.
Barry Ritholtz: Your podcast is named Capital Allocators, results in the apparent query, what share of, uh, capital ought to traders be interested by 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 inexpensive quantity of threat to take relative to the capital appreciation you’re searching for?
Ted Seides: Should you begin with the normal threat 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 would possibly wish to say, okay, I would like equity-like hedge funds. And when you take a look at a number of 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 whilst a lot as 90%, are non taxable traders. There are just some hedge fund methods, they usually are typically issues like activism which have longer length funding holding durations, that make sense for taxable traders.
Barry Ritholtz: Once 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 properly.
Barry Ritholtz: All proper. So when you’re not, you recognize, the Yale endowment, however you’re working a pool of cash, how a lot do it’s worthwhile to have to consider hedge funds in its place in your portfolio?
Ted Seides: You’re most likely within the double-digit hundreds of thousands earlier than it even is smart to consider it
Barry Ritholtz: 10 million and up and you would begin interested by it. After which what’s a rational share? Is that this a ten % shift or is that this one thing roughly?
Ted Seides: I do know for, for me individually, it’s so much 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, numerous hedge fund methods have quarterly liquidity, so it’s not each 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 once in a while, the place a hedge fund will say, “Hey, we’re, we’re, you recognize, a bit tight this quarter and we’re not letting any cash out.” How do you take care of 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 awesome match for the underlying liquidity of these debt devices.
Increasingly, these moved into medium-term, say two to five-year funding automobiles. And now you see way more of that within the personal credit score world that has an asset-liability match. It’s way more applicable for the underlying property. 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 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 good monetary disaster, hedge funds have struggled. Some folks 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 would go earlier than, you recognize, you’re within the backside half of the efficiency monitor.
Ted Seides: Over these final 15 years. the world has gotten much more aggressive. So for certain, 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 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 property 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’ve 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 numerous 2 & 20. And a part of that’s that charges are simply decided by provide and demand. Consider it as a clearing worth for provide and demand. So when returns usually 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, it’s worthwhile to 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 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 acquire any traction or, or the place are we with that?
Ted Seides: A lot of the establishments can be joyful to pay excessive charges for true alpha. There are at all times 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 joyful to pay so much for the alpha. On the similar time, there’s of the 5 trillion in property, 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 troublesome to alter, 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 a number of the largest misconceptions about investing within the hedge fund area?
Ted Seides: I believe the most important is the place you let off, which is that it’s sensational in any manner, form, or kind. The truth is, hedge funds, when performed properly, are fairly darn boring. And that’s most likely the most important false impression.
The opposite is that, you recognize, It’s a area that has numerous new exercise. The truth is, it’s fairly a mature trade at this cut-off date. 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 needs to be like watching paint dry or grass develop. If you’d like 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 e book: “The talent of capital allocation lies not to find 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 manner and so sure, it does matter to attempt to discover say an awesome hedge fund on this instance If that’s gonna match together with your portfolio, however what’s extra necessary is knowing What are your objectives and may these kinds of methods assist obtain your objectives?
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 you can allocate 5 % or 10 % to a fund that is perhaps a bit riskier and have a bit increased tax results, however concurrently might diversify your returns and will generate higher than anticipated returns, you would possibly wish to take into consideration this area.
You actually wish to assume intently about your technique and your liquidity necessities and pay attention to the truth that the perfect funds is probably not open to you and it’s possible you’ll not have sufficient capital to place cash in them. However when you’re sitting on sufficient money and you probably have recognized a fund that’s match together 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
