There are some numbers hedge fund investors need to know. Hedge fund fees is one of them. Financial Times did an analysis of hedge fund fees and returns (you can see the table below). They calculated that over the last 12 years hedge funds got 38% of their aggregate returns as management and performance fees. Here is what FT said:
Multiplying the assets under management by percentage returns, fees and outperformances gives dollar equivalents. Totalling such yearly dollar figures and dividing by the total of yearly assets under management gives the “average” yearly return to investors (7.1 per cent), of fees of hedge fund managers (4.3 per cent), and of brokers (the assumed 3 per cent).
The weighted average HFC returns (14.4 per cent) are financed by the “market return” (5.6 per cent), and the alpha of HFC outperformance of the market (8.8 per cent).
FT is basically saying two things. First, hedge fund investors were able to outperform the market by 1.3 percentage points annually on the average. So, a hedge fund investor made the right decision by investing in hedge funds in 1999. FT is also saying that hedge fund investors paid 4.3 percent annually to invest with hedge funds. So, hedge fund managers reaped most of the alpha they generated.
However, that’s not the right way to look at this. If you are considering to invest in hedge funds today, you shouldn’t look at hedge funds’ 12-year performance. You should take a look at their 5 year performance because that’s when hedge funds are really managing large sums of money. Over the last 5 years hedge fund investors made a total of $414 billion whereas hedge fund managers made a total of $363 billion. If they had invested in an index fund, they would have made $228 billion. Here is what this means for hedge fund investors:
1. They are still better off by investing in hedge funds. They beat the market by about $40 billion annually. That’s an outperformance of 2.5 percentage points per year.
2. Hedge funds collected 47% of their aggregate returns as fees. That’s 4.3 percentage points per year, which is nearly half of their total return.
Insider Monkey believes that investors can do better by imitating hedge funds’ stock picks. Imitating hedge funds isn’t straight forward. You get to see their long stock picks once a quarter and that’s with a 45 day delay in most cases. You also don’t see their short books. However, we don’t think this will cost investors nearly HALF of their returns. One of the best performing stocks in the market this year is Apple (AAPL). Apple has been among the top 3 most popular stocks since at least the end of 2010. Investors had plenty of time to imitate hedge funds’ bets in this case. Hedge fund managers keep most of the alpha they generate for themselves and become billionaires at the expense of their investors. Don’t you think a 4.3% management fee is too much?
