Oxstones Investment Club™Hedge fund stars shine above the crowd
Financial Times
James Mackintosh, Investment Editor, On Friday September 10, 2010, 1:51 pm EDT
George Soros has been the public face of the hedge fund industry since long before he made $1bn forcing sterling out the European exchange rate mechanism. The total money his Quantum fund has earned for clients, though, has rarely been discussed – and is extraordinary.
According to new research, the 80-year-old Mr Soros has produced $32bn for his customers since setting up in 1973, an average of over $900m a year. Put another way, Mr Soros and his team of 300 have made their investors more than the total earnings of Apple, which employs 34,300, or Alcoa, one of America’s 30 largest manufacturers.
When it comes to the hedge fund mantra of “absolute returns”, Mr Soros is leader of the pack.
But the top 10 most successful managers have between them generated almost $154bn since they were founded, with even the number 10 – Eddie Lampert’s ESL – making more than British Airways earned over the same period.
Rick Sopher at Edmond de Rothschild Group, chairman of Leveraged Capital Holdings, which has been investing in hedge funds since 1969, said the findings of his research demonstrated the trading skills of the best managers. It really pays to pick the best. The top 100 managers made more than three-quarters of all returns for investors since they were founded, in an industry estimated to have about 7,000 managers.
“There are these great managers who made tons of money but among the other 7,000 there’s a lot of disappointment,” he says.
Measuring hedge fund returns is complicated by the fact that investors tend to be flighty, flocking to funds which have done well and selling out of funds immediately after losses. As a result, investors in hedge funds tend to do far worse than the dazzling percentage returns reported by some managers suggest.
Ilia Dichev at Emory University in Atlanta and Gwen Yu at Harvard, in a forthcoming paper, have found that actual returns to investors are three to seven percentage points lower than headline returns. Since 1980, the average hedge fund annual return was 12.6 per cent. But, weighted for investment flows, the average investor received only 6 per cent, they found, well below equity returns and not much better than bonds.
The top 10 managers are mostly older funds, typically dating back to the early 1990s or before, and all but one is run by an American. Older funds have not just had more time to generate profits. Over the past decade the increasing number of institutional investors in the sector has led managers to reduce risk, damping returns.
For example, Bruce Kovner, founder of Caxton Associates, saw his Caxton Global fund come in at number four, with $12.8bn of profits for investors since 1983. His returns and volatility dropped dramatically at the end of the 1990s. This year the fund is up 5.14 per cent, well above the hedge fund average of 1.65 per cent, and in its 27 year life it has never had a losing year.
Mr Soros has had a sparkling crisis, returning to the form that saw him produce an annual average above 30 per cent from the 1970s to 2000.
John Paulson’s Paulson & Co famously made more money in a single year than any investor ever, thanks to its prescient bet against subprime mortgages. And the upstart on the list, Brevan Howard, founded just seven years ago, shot to fame and became Europe’s biggest hedge fund thanks to its returns during the crisis. These returns mean that over its short life it had the highest profits of any fund per year, at $1.8bn, although Mr Soros’s average of $900m since 1973 would be far higher if adjusted for inflation.
Alan Howard’s Brevan is the only British-managed fund in the top 10, although he and much of his team recently relocated from London to Geneva.
Nagi Kawkabani, co-chief executive of Brevan, says that, until it becomes clear whether the western world is heading back into recession or into recovery, it is likely that returns for all funds will remain depressed.
“Anyone who thinks they can consistently achieve more than 600-700 basis points [6-7 percentage points] over cash without taking a very large amount of risk or leverage is probably unrealistic,” he says, adding: “I think it is delusional. If money making opportunities were obvious the [interest] rates would not be zero.”
David Tepper, whose Appaloosa Management came seventh on the list, says it is hard to decide which way the economy is heading, and, as a result, he is keeping his fund heavily hedged with 10 per cent in cash.
“This is a time when reasonable people are so confused,” he says. “The analysis is very fine right now.” But he says the most likely outcome is that the US economy muddles through.
Mr Paulson, who has been buying gold and banks in the expectation of an inflationary recovery, disagrees. “We are as excited now as we have ever been about investment opportunities,” he said.
“Markets have fallen to a point that has created a historic moment to buy very high quality assets at distressed levels.”
The managers of all the top funds have become billionaires thanks to the fee structure, which typically allows them to rake off 2 per cent a year and 20 per cent of returns. Assuming they all applied this (some charge more), the total performance fees alone of the top 10 funds would be close to $40bn.
Every way of looking at performance is flawed, and an exclusive focus on dollar profits would tell investors little.
As an analysis tool, though, it puts absolute return back where it should be: at the heart of hedge fund management.
Tags: absolute returns, george soros, hedge fund stars, quantum fund