Hedge Funds and Funds of Funds: Biting the Hand That Feeds You

This WSJ article about hedge funds of funds contained the following juicy quote from a hedge fund manager, a sentiment widely held but seldom expressed in public:

"Funds of funds are, in general, a highly overrated bunch, many of them attracting people who can't manage money themselves," says Jonathan Trugman, who runs a small New York stockpicking hedge fund, Pendulum Capital Management, that made money in 2008. "You have to be selective about which funds of funds you do business with, because much of it is allocated more by marketers and back-slappers than by true analysts."

True enough, I confess, and Trugman deserves credit for his courage. But I have to laugh, because I am certain that, west of the Hudson River where the rest of the country earns a living, plenty of company CEOs express a similar sentiment, only it goes something like this:

Hedge funds are, in general, a highly overrated bunch, many of them attracting people who can't run companies themselves [but who love to tell others how to] . . .

The universal truth is, human beings simultaneously depend on and resent their dependence on their benefactors. Just as corporate managers resent those who provide the capital they need, hedge fund managers resent the capital providers on whom they depend (funds of funds provide about 40% of hedge fund capital, according to the article). Inject a hedge fund manager with truth serum and within minutes you'll get an earful about how stupid/"It's who you know, not what you know"/marketing-obsessed/short-term oriented a typical fund of funds is.

But this dynamic can be reversed. Those hedge fund manager selectors who don't behave this way, who stand out from their brethren by minimizing resentment, have a significant advantage. Here is the great Charles D. Ellis writing about David Swensen, from the forward to the new edition of Swensen's book:

. . . [money] managers prefer to work for and with clients they like and admire, and they like and admire David Swensen very much. They want to work with him and his team. This is why, despite its very high and rigorous screening standards, Yale attracts so many nimble, creative investment managers who are repetitively able to outperform. And the odds are high that most managers do their best work for Yale because Swensen & Co. work so conscientiously to facilitate and encourage them.