Thread by @doctorow

The fact that rich people buy something is often held up as proof that it's good, which is how you get Bernie Madoff frauds and subprime crises.

Nowhere is this more true than in money-management, especially hedge-funds.

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Hedge funds make investments on behalf of "high-net-worth individuals," institutional investors and since "being rich" is equated with "being good at money," you'd think that hedge fund managers were good at investing.

They are not.

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The vast majority of hedge-funds underperform a simple tracker fund every year, and virtually all funds underperform the market over the long-term.

marketwatch.com/story/hedge-fu…

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But wait: "vast majority" isn't the same as "all" so maybe all you have to do is pick a good hedge fund?

Sorry, nope, even when hedge-funds make good bets, they still underperform, because HEDGE FUND MANAGERS COLLECT 64% OF INVESTORS' GROSS RETURNS.

nakedcapitalism.com/2020/09/22-yea…

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Notionally, hedge fund managers live on a 2-and-20 structure: an annual fee of 2% of the money they manage, and 20% of the profits they generate. But a 22-year study published by @nberpubs reveals some next-level chicanery.

nber.org/papers/w27454

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The managers of hedge funds (and private equity funds) calculate their commissions in ways that are extremely beneficial to them, and that can only be parsed with extremely careful readings of performatively complex and dull agreements.

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As @yvessmith explains, PE managers "take fees on every deal that show a profit once a hurdle rate is met... firms sell good deals early and dogs later, meaning it’s pretty common for investors to have been charged carry fees on early deal profits wiped out by later losses."

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The mechanisms meant to guard against this have to be fought for and more often result in a "vague promise of getting a 'deal' on the next fund…which pre-commits them to invest with someone who underperformed and would not live up to his contact."

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That's PE funds - but hedge funds have their own versions. For example, losses on one hedge fund could not offset gains on a different fund - giving managers broad leeway to run "multiple funds with no offsets across funds run by the same hedge fund manager."

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And because hedge funds are relatively liquid, investors are allowed to pull out during downturns, "if they showed profits earlier so they give up the opportunity to have the losses offset against later gains."

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And withdrawals during downturns cause funds to shut down suddenly, with contracts that favor managers in these events; as the study's authors note, changing 2-and-20 to 1-and-30 would likely only increase managers' rake.

eof/