What Do Apple, Facebook, Alphabet and Hedge Funds Have in Common?

And that’s exactly what has been happening in recent years. Index funds are growing rapidly, hedge funds are growing rapidly, and the share of the stocks that are owned by retail investors and actively managed has been shrinking. By the way some academic studies estimate that retail investors underperform the market by about 8 percentage points annually. When these investors stop actively picking stocks, there is less alpha to be picked up by hedge funds. So, in recent years, the size of the alpha available for hedge funds has been shrinking and the number and the size of hedge funds trying to capture this have been increasing at a rapid pace.

As a result, the average alpha generated per hedge fund has been declining rapidly. We may be at the point where the total fees charged by hedge funds are greater than the total alpha generated by hedge funds. Hedge funds aren’t in trouble because they are underperforming a bull market. Any investor with half a brain knows that hedge funds which are usually at least partially hedged will outperform in bear markets and underperform in bull markets (yea, most members of the media either don’t have half a brain or just pretend that they don’t understand this simple fact). Hedge funds are in trouble because their alpha is becoming smaller than their fees.

You can fool some of the people some of the time but you can’t fool all investors all the time. These days hedge funds are trading against each other because dumb retail investors are leaving the market. Some hedge funds are good at investing and marketing, and the remaining hedge funds are good at marketing. I will listen to the presentations of these hedge fund managers today and tomorrow at the SALT Conference. Some of them are truly brilliant investors and they know their limits. These people generally close their hedge funds to new investors. I am pretty certain that these hedge funds will continue to pick winning stocks at the expense of remaining retail investors in the market as well as other hedge funds that are very good at marketing but not investing. You will keep reading stories in the media about these high profile hedge funds blowing up. At the end of the day remember that markets aren’t infinite in size. Apple Inc. (NASDAQ:AAPL), Facebook Inc (NASDAQ:FB), Alphabet, and hedge funds as a group can’t keep growing forever.