This is the time of year when investors and advisors alike review the performance of their investment of the past twelve months. Incredibly, equity markets closed the year at an all-time-high. Not something we would have bet money on in late March.
After the exquisitely nerve-rattling panic of 1Q-2020, equity markets rallied for the rest of the year. Investment performance however, was widely disparate, with all of the up-market action concentrated in the new-new, growthy names and fueled by legions of new novice investors stampeding to platforms like Robin Hood and chasing the same names. Conversely, staid old blue-chips that pay dividends were stuck in the mud.
Events of 2020 made clear that some structural changes will be long-term trends: working from home, shopping more online, the need for clean sustainable energy, to name a few.
Re-visiting Hobbyhorse Number One
One of the things we pay attention to is the business of hedge funds, otherwise known as a compensation scheme masquerading as an investment vehicle.
Late in 2020, Bloomberg published two articles about two prominent hedge funds. We’ll call one Greenhorn and the other Majestic, to protect the guilty. Bloomberg reports that Greenhorn had a tough year and in fact has lost 34% since the end of 2014. This while the benchmark index S&P 500 gained…wait for it…105%. The once hot-hand has grown cold and Greenhorn’s assets have dwindled from $12 billion in 2015 to $2.6 billion now. Still with the standard hedge fund asset management fee of 2.0%, firm revenues are probably close to $50 million annual and no-one is eating cat food just yet. But it does not seem like good value for money.
Compare that to Majestic. Also as reported by Bloomberg, Majestic had its best year since 2000 returning close to 23% for the year through mid-December. Majestic has been gaining clients and assets under management now approach $50 billion. The standard hedge fund fee of 2.0% yields annual revenue of something near $1 billion, before any incentive fees are collected. A fine business indeed. But is it delivering value for money?
The Rationale: Does It Hold Up?
Hedge fund operators charge a lavish fee and justify it with claims of delivering excess (over some agreed benchmark or hurdle rate) returns. Now 23% is a fine return, but let’s put that into context. The S&P 500 gained 18.4% on 2020 and the MSCI Broad Equity Index gained 21.0% Any investor could have earned those equity returns through an ultra low cost ETF for literally pennies per $1,000. But wait, there’s more.
The Vanguard Growth ETF gained 35% in 2020. The tech heavy QQQ gained 46%, both also for pennies per $1,000. Annual revenues for the Vanguard Growth ETF will be approximately $20 million on an asset base of $50 billion….compared to $1 billion for Majestic.
Is This Rational?
As Vanguard Founder Jack Bolge stated so simply and eloquently, client returns are NET of FEES…that is clients returns are diminished by fees. That is true across the financial services industry. The question is one of balance. Does it make sense to pay a hedge fund manager a 2% or more fee for a 23% return when any investor could have done quite a bit better with a simple index fund? Which brings us to the next issue.
The Heavy Lifting
Of course it all comes down to asset allocation, diversification (or not), and implementation. Someone (investor, advisor, manager, fiduciary, trustee) has to decide or delegate. We don’t claim that any hedge fund client could have had 100% of their assets in the Vanguard Growth or similar vehicle…would be imprudent. And another thing. No investor (certainly no institutional investor) has all their assets with one entity like Majestic. They might have had an equal amount with Greenhorn. IN that case the investor earned a blended return of about 11% in 2020 (23% from Majestic and -1% from Greenhorn) for a blended rate near 11%. That 2% is looking worse all the time. And inevitably, today’s hot hand becomes tomorrow’s cold fish. And the clients continue to pay the freight for what ultimately are modest, blended returns that could be had for pennies.
Thanks for indulging another rant about the systemic transfer of wealth from asset owners to hedge fund managers. From where we sit it does not make sense for the investors.