0:00

Metas Open Source AI, available to

0:02

all, not just the few. Here's

0:04

Steve McCloskey, CEO of Nanom. With

0:06

Metas Open Source AI Model Lama,

0:08

we built a tool to help

0:11

scientists to discover treatments for diseases.

0:13

Learn more at AI. meta.com slash open.

0:15

This show is sponsored by Better

0:17

Help. Better Help been revolutionary

0:19

in connecting. connecting mental health

0:21

services. health help can be as easy

0:24

as opening your laptop or your

0:26

phone your a button or

0:28

your session and clicking a button and

0:30

able to choose in what way they

0:32

would like to communicate with me,

0:34

whether video like on the phone

0:36

or with me, whether video or is there

0:38

when you need it, and

0:40

that's what makes all the

0:42

difference. and that's what makes.com slash Visit better

0:44

get to... to get 10%

0:47

off your first

0:50

month. Therapists

0:55

were compensated.

0:59

Bloomberg

1:02

Audio

1:05

Studios.

1:08

Podcasts,

1:11

Radio News.

1:28

2032. But not all hedge funds

1:30

are created equally. Investors

1:32

should ask themselves, is

1:34

this the right investment

1:36

vehicle for me? I'm Barry Rittoltz and

1:38

on today's edition of At the Money,

1:40

we're going to discuss how you should

1:42

think about investing your money in hedge

1:44

funds. To help us unpack all of

1:47

this and what it means for

1:49

your portfolio, let's bring in Ted

1:51

Cite's. Ted began his career under

1:53

the legendary David Swenson at the

1:55

Yale University Investments Office. Today he's

1:57

founder and CEO of Capital Allicators.

1:59

hosts a podcast by the same

2:01

name, his book, so you want

2:03

to start a hedge fund. Lessons

2:06

for managers and alligators, is the

2:08

seminal work in the space. So

2:10

Ted, let's start out with the

2:12

basics. Why hedge funds? What's the

2:14

appeal? The original premise of hedge

2:16

funds was to deliver an

2:19

equity-like return in marketable

2:21

securities with less risk than

2:23

the equity markets. So literally

2:25

hedged. funds. A fund that

2:27

had some hedging component that

2:29

would reduce risk. And today, I

2:32

think a lot of so-called hedge

2:34

funds are not exactly hedged. They

2:36

seem to be falling into all

2:38

sorts of different silos. Yeah, so

2:40

hedge fund as a term became

2:42

this very ubiquitous label. And if

2:44

you look at how the industries

2:47

evolved today... You have funds that

2:49

fall under hedge funds that look

2:51

like that original premise of equity-like

2:53

returns, and then you have a

2:55

whole other set that look more

2:57

like bond-like returns. And different strategies

2:59

can fit into those two different

3:02

groupings. So I mentioned in the

3:04

introduction, we always seem to hear

3:06

about the top 2% of fund

3:08

managers who are the rock stars.

3:11

Anyone who puts up like really

3:13

big numbers wildly up before in

3:15

the market sort of gets feted

3:18

by the media and then they

3:20

sort of fade back into what

3:22

they were doing. It seems to

3:25

create unrealistic expectations among a lot

3:27

of investors. What sort of investment

3:29

return expectations should people investing in

3:32

hedge funds have? Yeah. Those expectations

3:34

should be more modest than what

3:37

you might read in the press.

3:39

Barry, what you just described describes

3:41

markets. People do well. They revert

3:44

to the mean. It happens in

3:46

every strategy. And certainly the news

3:48

sensationalizes great performance and lousy performance.

3:51

So what you might read in

3:53

the press is these incredible Renaissance

3:56

medallion 50% a year with these

3:58

high fees. 68%. I recall Zuckerman's

4:00

book, Greg Zuckerman's book on Jim

4:03

Simon. Now if you looked at

4:05

hedge funds as a whole and

4:07

try to get at, let's say,

4:10

that equity-like expected return, you're talking

4:12

about like a high single digits

4:15

number. It has nothing to do

4:17

with 68%. Most of the action

4:19

isn't on either tail. Most of

4:22

the actions right in the middle.

4:24

That seems to be very... contrary

4:26

to how we read and hear

4:29

about hedge funds in the media,

4:31

is it that whoever's hot at

4:33

the moment captures, you know, the

4:36

public's, hot at the moment captures,

4:38

you know, the public's fancy, and

4:40

then on to the next, that's

4:43

not how the professionals really think

4:45

about the space, is it? No,

4:47

that's right. I think that's generally

4:50

how the media works at investing.

4:52

The news stories are the things

4:55

that are on the tails, but

4:57

it's not how hedge funds are

4:59

invested in by those who have

5:02

their money at risk. They're really

5:04

looking at it as risk mitigating

5:06

strategies relative to your say traditional

5:09

stock and bond alternatives. So we

5:11

talk about Alpha which is outperformance

5:13

over what the market gives you

5:16

which is beta Lately it seems

5:18

that Alpha comes from two places

5:20

emerging managers new fund managers who

5:23

kind of identify market inefficiency and

5:25

the quants who have seemed to

5:27

be doing really well as of

5:30

late. What do you think about

5:32

these two sub sectors within the

5:35

hedge fund space? Well all of

5:37

asset management there's this aphorism size

5:39

is the enemy of performance and

5:42

it's certainly been true in hedge

5:44

funds that generally speaking for a

5:46

long time smaller funds have done

5:49

better than larger funds. Not so

5:51

sure that's the case of emerging

5:53

funds, which means new, but on

5:56

size you get that. Now what's

5:58

an interesting dynamic and it gets

6:00

into the quant, is more and

6:03

more money. has been sucked in

6:05

by these so-called platform hedge funds.

6:08

So Citadel, Millennium, 0.72, places like

6:10

that, where they have multiple portfolio

6:12

managers and do a phenomenal job

6:15

at risk control. And they've seemingly,

6:17

in good markets and bad, generated

6:19

that nice equity-like expected return. And

6:22

there has to be alpha in that

6:24

because there's not a lot of beta.

6:26

That's really kind of interesting.

6:29

You said something in your

6:31

book that resonated with me.

6:33

The best allocators establish clear

6:35

processes for evaluating opportunities and

6:38

setting priorities. Explain what you

6:40

mean by that. Well, before

6:42

you just decide, I want

6:45

to invest in a hedge

6:47

fund. It's really important to

6:49

understand how are you thinking

6:51

about your portfolio and

6:54

how do hedge funds fit in? hedge

6:56

funds can mean lots of different things

6:58

and that the strategies pursued by one

7:00

hedge funds is going to look totally

7:02

different from another one. So you need

7:04

to understand what is it you're trying

7:07

to accomplish? Are you trying to beat

7:09

the markets with your hedge fund allocation?

7:11

Okay, you better go to one that

7:13

takes a lot of hedge fund allocation?

7:15

Okay, you better go to one that

7:17

takes a lot of aggressive risk. Are

7:20

you trying to beat the bond markets?

7:22

You better go to one that doesn't

7:24

take equity. risk. So you need to

7:26

understand in advance what is it

7:28

you're trying to accomplish through that

7:30

investment and then go look for

7:32

the solution. Not the other way

7:35

around just by saying, oh hedge

7:37

funds are a good thing, let

7:39

me go invest in them. So

7:41

that sounds a lot like another

7:43

phrase I read in the book, an

7:45

acute awareness of risk. Should investors

7:47

be thinking about performance first or

7:50

are these two sides of the

7:52

same coin? They are two

7:54

sides of the same coin, but

7:56

without a doubt investors should be

7:59

thinking. at risk first. And

8:01

that's not specific to hedge funds.

8:03

I would argue that's true in

8:06

all of investing. If you understand

8:08

the risk you're taking and you

8:10

look for some type of asymmetry

8:13

or convexity, the rewards can take

8:15

care of themselves. But where you

8:17

really get tripped up in hedge

8:20

funds and there's a long history

8:22

of this going back to long-term

8:25

capital in 1998 is when risk

8:27

gets out of control. long-term capital

8:29

management very famously blew up when

8:32

Russia defaulted on their bonds. They

8:34

were leveraged a hundred to one,

8:36

so this wasn't like a bad

8:39

year. This was pretty much a

8:41

wipeout. How can an investor evaluate

8:44

those risks in advance? Well, there

8:46

are three pillars that don't go

8:48

together well. Concentration, leverage, and illiquidity.

8:51

You can take any one of

8:53

those risks, but if you take

8:55

two or certainly three at the

8:58

same time That's a recipe for

9:00

disaster. So your podcast is called

9:03

capital allocators leads to the obvious

9:05

question What percentage of capital should

9:07

investors be thinking about allocating to

9:10

hedge funds? Whether they're a large

9:12

institution or just a high net

9:14

worth family office Where do we

9:17

go in terms of what's a

9:19

reasonable amount of risk to take

9:22

relative to the capital appreciation you're

9:24

seeking? Well, if you start with

9:26

a traditional risk construct, so let's

9:29

say that's a 70-30 stock bond

9:31

or 60-40, say 70-30, the question

9:33

becomes outside of your stocks and

9:36

bonds, where can you get diversification?

9:38

And you might want to say,

9:41

okay, I want equity-like hedge funds.

9:43

And if you look at some

9:45

of the most sophisticated institutions, that

9:48

might be as much as 20%

9:50

of their portfolio. The biggest difference

9:52

for those institutions and the high

9:55

net worth individuals are taxes. Most

9:57

hedge fund strategies are tax inefficient.

10:00

of that $5 trillion, the vast

10:02

majority of it, maybe even as

10:04

much as 90%, are non-taxable

10:06

investors. There are only some

10:08

hedge fund strategies, and they

10:10

tend to be things like

10:12

activism that have longer duration

10:14

investment holding periods that make

10:16

sense for taxable investors.

10:18

So, and when you say

10:20

non-taxable investors, I'm thinking of

10:23

foundations and dalments. Large not

10:25

even tax deferred just tax exempt entities

10:27

that can put that money to work

10:29

without worrying about Uncle Sam is that

10:31

is that right? That pension funds non-u.s

10:34

investors as well All right, so if

10:36

you're not you know the Yale Endowment,

10:38

but you're running a pool of money

10:40

How much do you need to have

10:42

to think about hedge funds as an

10:45

alternative for your portfolio? You're

10:47

probably in the double-digit millions before it

10:49

even makes sense to think about

10:52

it 10 million and up and

10:54

you could start thinking about it

10:56

and then what's a rational percentage?

10:59

Is this a 10% shift or is this

11:01

something more or less? I know for

11:03

me individually it's a lot less

11:05

than it was when I was

11:07

managing capital for institutions so for

11:09

me individually it's about 5% because

11:11

I need to feel like the

11:13

managers are so good that they

11:15

can make up for that tax

11:17

disadvantage. And so taxes

11:19

are part of it. illegally is part

11:21

of it and risk is part of

11:24

it. Are those the, is that the

11:26

unholy trifecta that keeps you at 5%?

11:28

Yeah, depending on the strategy, a lot

11:30

of hedge fund strategies have quarterly liquidity,

11:32

so it's not daily, but they are

11:35

relatively liquid. But for sure. taxes matter

11:37

and then it's just risk. How much

11:39

risk are you willing to take in

11:41

the markets? And you know since you

11:44

mentioned liquidity, we hear about gates going

11:46

up every now and then where a

11:48

hedge funnel say, hey we're we're you know

11:50

a little tight this quarter and we're not

11:52

letting any money out, how do you deal

11:55

with that as an investor? You have to

11:57

be very careful about what the structure of

11:59

your investment... is. So to take an

12:01

example, in the world of credit,

12:03

distressed debt used to be bucketed

12:05

in hedge fund strategies with quarterly

12:07

liquidity, but it's not a great

12:09

match for the underlying liquidity of

12:11

those debt instruments. More and more

12:13

those moved into medium terms, say

12:15

two to five year investment vehicles,

12:17

and now you see much more

12:20

of that in the private credit

12:22

world that have an asset liability

12:24

match that's much more appropriate for

12:26

the underlying assets. So it's less

12:28

what the liquidity is and trying

12:30

to make sure that whatever that

12:32

hedge fund manager is investing in

12:34

is appropriate for the liquidity that

12:36

they're offering. So let's talk a

12:38

little bit about performance. before the

12:40

financial crisis. It seemed that every

12:42

hedge fund was just killing it

12:44

and printing money following the great

12:46

financial crisis. Hedge funds have struggled.

12:48

Some people have said, you only

12:50

want to be in the top

12:52

decile or two. What are your

12:54

thoughts on who's generating Alpha and

12:56

how far down the line you

12:58

could go before you're in the

13:00

bottom half of the performance track?

13:03

Yeah. I mean, over these last

13:05

15 years. the world has gotten

13:07

a lot more competitive. So for

13:09

sure, whatever pool of Alpha was

13:11

available before the financial crisis, if

13:13

it's the same pool, there are

13:15

a lot more dollars pursuing it

13:17

and it's been much harder to

13:19

extract those returns. So I do

13:21

think it's become the case that

13:23

some of the more proven managers

13:25

that have demonstrated they can generate

13:27

excess returns are the ones who

13:29

have commanded more dollars. And so

13:31

you've seen an increased concentration of

13:33

the assets going to certain managers

13:35

in the hedge fund space. Let's

13:37

talk about fees. Two and 20

13:39

has been the famous number for

13:41

hedge funds for a long time,

13:44

although we have heard over the

13:46

past 10 years about one in

13:48

10, one in 15. Where are

13:50

we in the world of fees?

13:52

You don't see a lot of

13:54

two in 20, and part of

13:56

that is that fees are just

13:58

a... determined by supply and demand.

14:00

Think of it as a clearing

14:02

price for supply and demand. So

14:04

when returns generally have come down,

14:06

those strategies don't really command as

14:08

high a fee structure because the

14:10

gross return is lower. The pie

14:12

is a little smaller. You need

14:14

to take a smaller slice of

14:16

that pie. The exceptions to that,

14:18

of course, are the managers who

14:20

have continued to deliver. And in

14:22

some instances, you actually see fees going

14:25

up. Three and 30. You've seen D.

14:27

Shaw raised their fees a year or

14:29

two ago, but for the most part,

14:31

that kind of one and a half

14:34

and 15 is probably around where the

14:36

industry is. And there was a movement

14:38

a couple of years ago towards pivot

14:40

fees or beta plus, which was, hey,

14:43

we're going to charge you a very

14:45

modest fee and you're going to pay

14:47

us only on our outperformance over the

14:49

market. What happened with that movement?

14:52

Did that gain any traction or

14:54

where are we with that? Most of

14:56

the institutions would be happy to

14:58

pay high fees for true alpha.

15:00

So there are always efforts to try

15:03

to figure out how do you separate

15:05

the alpha from the beta, how can

15:07

we pay not much for the beta,

15:09

and happy to pay a lot for

15:11

the alpha. At the same time...

15:13

of the five trillion in assets,

15:15

two or three trillion have existed

15:17

before people started talking about that.

15:19

So you already had a handshake

15:21

on what the deal is. Those

15:23

handshakes often are difficult to change,

15:25

but for sure in new structures

15:28

when new capital gets allocated you

15:30

do see that attempt to really

15:32

isolate paying for performance. So

15:34

to sum up. If you have

15:36

a long-term perspective and you're not

15:39

odd by some of the big

15:41

names and rock stars who occasionally

15:43

put up spectacular numbers and you're

15:46

sitting on enough capital that

15:48

you can allocate 5% or 10%

15:50

to a fund that might be

15:53

a little riskier and have a

15:55

little higher tax effects, but simultaneously

15:57

could diversify your return. and

16:00

could generate better than expected returns,

16:02

you might want to think about

16:05

this space. You really want to

16:07

think closely about your strategy and

16:09

your liquidity requirements. And be aware

16:12

of the fact that the best

16:14

funds may not be open to

16:16

you and you may not have

16:19

enough capital. to put money in

16:21

that, but if you're sitting on

16:23

enough cash and if you have

16:26

identified a fund that's a good

16:28

fit with your strategy and your

16:30

risk tolerance, there are some advantages

16:33

to hedge fund investing that you

16:35

don't get from traditional 60-40 portfolios.

16:37

I'm Barry Rittholtz. You're listening to

16:40

Bloombergs at The Money. is

17:31

supported by Better Help, offering licensed

17:33

therapists you can connect with via

17:36

video, phone, or chat. Here's Better

17:38

Help head of clinical operations, HESHU

17:40

Joe, discussing who can benefit from

17:43

therapy. I think a lot of

17:45

people think that you're supposed to be

17:47

going to therapy once you're like having

17:49

panic attacks every day, but... Before you

17:51

get to that point, I think once

17:53

you start even noticing that you feel

17:56

a little bit off and you can't

17:58

maintain this harmony that you once had

18:00

in relation that

18:19

you could benefit from talking to

18:22

somebody. Find out if therapy is

18:24

right for you. Visit betterhealth.com. are

18:26

and how we behave with other

18:28

people. So if you're human, that's

18:31

like a good indicator that you

18:33

could benefit from talking to

18:35

somebody. Find out if therapy

18:37

is right for you. Visit

18:39

betterhelp.com today. That's better help.com.