A Look at Hedge Fund Performance in 2008, 2009

by: Nick Gogerty

Sorry to be so Mean about this, but in Hedge fund land one is mostly paid on performance. Performance is typically calculated as the metric from the last high water mark of the fund on a monthly or quarterly basis. This is the famous 20% performance fee from a typical 2% management fee & 20% performance deal.

Unlike bankers, there is rarely a bailout in hedge fund land. Fraud aside, pay is not fudged or begged based on the ridiculous threat of a loss of talent. In my mind, if a bailed out bank can't afford to keep talent, that is perhaps a market signal that they are in the wrong line of business. I would suggest getting in the soup line like everyone else.

I have a strong aversion to the dollar received which is not earned or inherited. In the normal economy, such gains are correctly identified as thievery or extortion. To paraphrase Stalin, "Steal $400 from a liquor store and it is a crime, steal $180 billion from the government and it is preventing systemic contagion."

Hint: I have testified before the US senate on systemic banking contagion in the past and don't know if it wouldn't have been such a bad thing. I think systemic failure is still looming. We simply transferred a large banking risk and made it into a huge government risk, but we can discuss that after the US AAA rating is gone in 2-3 years.

Your average banker isn't really that talented, they are just nice white collar professionals. I say this having managed 70 Phd's at what was supposed to be one of the worlds most advanced science research labs and also having spent a bit of time among bankers, traders and hedgies. A lot of senior bankers hate the business, but got into it because it looked like money or appeared to be where the cool kids went. Many have a lifestyle trap where they can't earn to burn as much anywhere else and their sense of self-worth is too tied to net worth to quit now.

Most bankers were just in the right place for a long enough time and have social connections which means they have "political value". In anthropology we call this ascribed status via established trust networks and seniority. This is used to get the deal done, etc. Schmoozing and cultivating trust networks are hardly skills worthy of the salaries now commanded. Trust networks are important in culture, but must be kept in context.

Trust networks are solely social affectations, not hallmarks of a truly magical skill and certainly not worth $100's of millions of dollars. I do believe the private sector should be in charge of its own pay, but also believe there are systemic structural and regulatory failings that allowed things to get out of hand.

There is no huge body of knowledge or innovation in banking worthy of such extreme salaries as seen. On the contrary there probably hasn't been a real paradigm shifting innovation in finance since double entry accounting by Luca Pacioli in the 15th century. Most derivatives-related innovations are cheap semi- descriptive derivations of brownian motion lacking the explanatory power or rigor found in a true science. Approximating shaky mathematical tautologies and models that fail in the extremes is hardly a science.

Banking is a social interaction of trust and reputation, mostly an awkward dance of alpha males surrounded by capitulating underlings reinforcing a hierarchy of influence all papered over by a coterie of lawyers. It is a mating ritual of balance sheet bravado and bullshit.

I have limited sympathies for the senior bankers of the world, with the exception of the back office minions who mostly toil for fair wages. Most bankers perform a needed function, but deserve no special status in our culture such as the extremely deviant pay now still seen and expected.

Sadly, the entitlement belief is so rampant in this sector it beggars belief. Shame is an emotional development that is anathema to the successful senior banker. Ask Stan O'Neal or Sandy Weill, they can explain this shame void as they live it. They live in the mutual appreciation society of looking at their peers to determine their value. And yes, I come from studying, watching and participating in hedge fund land and banker land for 20 years, so I have a few beliefs and biases.

Hedgies have had a few lean years after 2007 and many are still below their high water marks. Of course the little secret in the business is that when a new customer switches accounts out of fear from a previous burn, they will all of a sudden pay for their new performance. Nothing soothes the loss of an unhappy old client with an awkward highwater mark so much as a new replacement client.

Keep them dancing and chasing performance is the name of the game. So If one stuck to the same hedge fund sector but merely shifted managers, they may have gotten hit this year with the 20% performance fee, but still be under water for the past 2 years.

Hedge fund performance 2008 2009

A little about the table porn above. The data was lifted from hennesseegroup and thus probably has the biases of all hedge fund data, survivorship and representation biases etc.

I post the geometric returns to indicate what the ride has been like since Jan. 2008. Speaking of average hedge fund returns is a bit like saying the average animal in the zoo is 5 years old. The average of such a diverse array of assets isn't very useful. It is a factoid with limited value.

A capital or Asset Under Management [AUM] weighting for this data may indicate the state of an approach. Median performance is perhaps a better representation than the average for many people's experience. With all representational stats, it depends on what you are looking for. A good introduction to statistical biases is the book, "the flaw of averages".

OK and now for a personal gripe: the Obtuse CNBCesque Question

Another thing that gets to me is the CNBCesque question I was asked the other day, "Which asset class or sector do you think will do best next year?" The only thing more silly than asking that question is answering it.

Implicit in answering is the presumption that one knows the performance of all asset sectors in the coming year. Awareness of self ignorance and admission of what one doesn't know is the start of the pursuit of knowledge. Presentation of omniscience is the hallmark of hubris.

Here is the data from the table above in excel 2007 Download Spreadsheet Gogerty.