On the Cash: Are Hedge Fund Proper For You? (February 5, 2025)
At 5 trillion {dollars}, hedge funds have by no means been extra common — 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 ought to be allotted? Hiow a lot additonal danger do you assume or keep away from?
The complete transcript is beneath.
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This week’s visitor: Ted Seides is the founder and CIO of Capital Allocators. He realized about alts working below the legendary David Swensen on the Yale College Investments Workplace. His newest guide is Non-public Fairness Offers: Classes in investing, dealmaking, and operations.
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Masters in Enterprise interview
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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 about placing some cash into hedge funds? 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 belongings immediately, 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 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 to your portfolio. Let’s usher in Ted Seides, Ted started his profession below the legendary David Swenson on the Yale College Investments Workplace.
Immediately, he’s founder and CIO of Capital Allocators and hosts a podcast by the identical identify, his guide, “So You Wish 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 danger than the fairness markets.
So actually hedged funds, a fund that had some hedging part that would scale back danger.
Barry Ritholtz: And immediately, I believe plenty of so referred to as hedge funds should not precisely hedged. They appear to be falling into all types of various silos.
Ted Seides: Hedge fund as a time period grew to become this very ubiquitous label. And should you have a look at how the trade has advanced immediately. You may have funds that fall below hedge funds that seem like that authentic premise of equity-like returns. After which you’ve gotten an entire 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 in regards to the high 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 have been doing. It appears to create unrealistic expectations amongst plenty of traders. What kind of funding return expectations ought to folks investing in hedge funds have?
Ted Seides: These expectations ought 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 unbelievable Renaissance Medallion, you already know, 50 % a 12 months with these excessive charges.
Barry Ritholtz: 68%. If I recall, Greg Zuckerman’s guide on Jim Simons.
Ted Seides: Now, should you checked out hedge funds as an entire 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%. Many of the motion isn’t on both tail. Many 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 for the time being captures, you already know, the general public’s fancy after which on to the following? That’s not how the professionals actually take into consideration the area, 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, 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 options.
Barry Ritholtz: So we speak about alpha, which is outperformance over what the market offers you, which is beta. These days, it appears that evidently alpha comes from two locations: Rising managers — the brand new fund managers who form of establish market inefficiency; and the quants who’ve gave the impression to be doing very well as of late. What do you concentrate on these two sub sectors throughout the hedge fund area?
Ted Seides: In all of asset administration, there’s this aphorism, dimension 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 carried out higher than bigger funds. Not so positive that’s the case of rising funds, which implies new, however on dimension you, you get that.
Now what’s an attention-grabbing 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 outstanding job in danger management.
They usually’ve seemingly, in good markets and dangerous, generated that good equity-like anticipated return. There must be alpha in that as a result of there’s not plenty of beta.
Barry Ritholtz: You stated one thing in your guide 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 determine, I need to put money into a hedge fund, it’s actually vital to know how are you serious about your portfolio and the way do hedge funds slot in. Now, be mindful, 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 essential perceive, what’s it you’re attempting to perform. Are you attempting to beat the markets along with your hedge fund allocation? Okay, you higher go that takes plenty of aggressive danger. Are you attempting to mitigate fairness danger, however get equity-like returns? Okay. You may need 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 prematurely, what’s it you’re attempting to perform by way of that funding after which go search for the answer, not the opposite manner round, simply by saying, oh, hedge funds are an excellent factor, let me go put money into them.
Barry Ritholtz: That sounds so much like one other phrase I learn within the guide, an acute consciousness of danger. Ought to traders be serious about efficiency first? Ought to they be serious about danger first? Or are these two sides of the identical coin?
Ted Seides: They’re two sides of the identical coin, however no doubt, traders ought to be serious about danger first. And that’s not particular to hedge funds. I might argue that’s true in all of investing.
For those who perceive the danger you’re taking and also you search for some sort of asymmetry or convexity, the rewards can handle 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 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: 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 should you take two or definitely 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 serious about allocating to hedge funds? Whether or not they’re a big establishment or only a high-net-worth household workplace, the place will we go when it comes to what’s an affordable quantity of danger to take relative to the capital appreciation you’re searching for?
Ted Seides: For those who begin with the normal danger assemble, so let’s say that’s a 70 30 inventory bond or 60/40, say 70/30, the query turns into, exterior of your shares and bonds, the place do the place are you able to get diversification?
And also you may need to say, okay, I need equity-like hedge funds. And should you have a look at a number of the most refined establishments, that is likely to be as a lot as 20 % of their portfolio. The largest 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, perhaps whilst a lot as 90%, are non taxable traders. 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 traders.
Barry Ritholtz: If you say, non taxable traders, 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. traders as effectively.
Barry Ritholtz: All proper. So should you’re not, you already know, the Yale endowment, however you’re operating a pool of cash, how a lot do it’s essential have to consider hedge funds in its place to 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 would begin serious about 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 have to 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 danger is a part of it. Is that the unholy trifecta that retains you at 5%?
Ted Seides: Relying on the technique, plenty 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 soak up the markets?
Barry Ritholtz: And, you already know, because you talked about liquidity, we hear about gates going up every so often, the place a hedge fund will say, “Hey, we’re, we’re, you already know, a bit of 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 this 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 automobiles. And now you see way more of that within the non-public credit score world that has an asset-liability match. It’s way more acceptable for the underlying belongings. So it’s much less what the liquidity is and attempting to ensure 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 of 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 stated, you solely need to be within the high 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 already know, 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 obtainable 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 more durable 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’ll 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 area.
Barry Ritholtz: Let’s speak about 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 this planet of charges?
Ted Seides: You don’t see plenty 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 payment construction due to the gross return is decrease, the pie is a bit of 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 situations, you really 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 probably the most half, that form 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 the 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: Many of the establishments could be glad 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 glad to pay so much for the alpha. On the similar time, there’s of the 5 trillion in belongings, 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 typically are troublesome to vary, however for positive in new buildings, when new capital will get allotted, you do see that try to essentially isolate paying for efficiency
Barry Ritholtz: What are a number of the greatest misconceptions about investing within the hedge fund area?
Ted Seides: I believe the largest is the place you let off, which is that it’s sensational in any manner, form, or type. Actually, hedge funds, when carried out effectively, are fairly darn boring. And that’s most likely the largest false impression.
The opposite is that, you already know, It’s a area that has plenty of new exercise. Actually, it’s fairly a mature trade at this time limit. And a lot 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 ought to be like watching paint dry or grass develop. In order for you some pleasure, take 800 bucks and go to Vegas.” There undoubtedly is a few, some reality to that.
Remaining query which is a quote of yours from the guide: “The talent of capital allocation lies not to find an excellent funding, however in figuring out the one that matches finest with the allocator’s technique and constraints.” Focus on that.
Ted Seides:We talked about a bit of earlier, no funding suits Each investor the identical manner and so sure, it does matter to attempt to discover say an ideal hedge fund on this instance If that’s gonna match along with your portfolio, however what’s extra vital is knowing What are your objectives and may some of these methods assist obtain your objectives?
Barry Ritholtz: To sum up, in case you have a long run perspective and also you’re not awed by a number of the massive names and rock stars who sometimes put up spectacular numbers, and also you’re sitting on sufficient capital that you may allocate 5 % or 10 % to a fund that is likely to be a bit of riskier and have a bit of larger tax results, however concurrently might diversify your returns and will generate higher than anticipated returns, you may need to take into consideration this area.
You actually need to assume intently about your technique and your liquidity necessities and pay attention to the truth that the perfect funds might not be open to you and it’s possible you’ll not have sufficient capital to place cash in them. However should you’re sitting on sufficient money and in case you have recognized a fund that’s an excellent match along with your technique and your danger 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
