Last September, I wrote that I would write about the four big categories of alternative investments, as defined by the CFA Institute:
- Hedge funds
- Commodities and Natural Resources
- Real Estate and Infrastructure
- Private Equity and Private Credit
Well, five months have passed, and I forgot all about it, but two articles I read recently reminded me.
In January, the Wall Street Journal reported on a new study that showed that hedge fund investors have lost half of their returns to fees.
The report by LCH Investments said that from 1969 through today, hedge funds earned $3.72 trillion in profits. However, those investors paid the managers $1.8 trillion in fees, which is 48.7 percent of the total. Wow!
Earlier this month, Bloomberg showed how hedge fund ‘pass through’ fees are gobbling up investor returns.
Traditionally, hedge fund managers charged “two and twenty,” which means a two percent management fee and 20 percent of the profits. In recent years, some large and highly sought-after firms with great performance started to pass through other costs to investors.
The pass-through fees started out as computer hardware that the hedge funds needed to speed up their trading and beat competitors. When investors didn’t balk and returns remained strong, hedge fund owners realized that they could make more money if they passed along the expenses of their business.
The article highlights one fund that earned 15.2 percent in 2023 gross of fees, but after a management fee of -1.8 percent, a performance fee of -0.3 percent, and pass-through fees of -10.3 percent, investors only netted 2.8 percent. Shocking!
I realize that I am not explaining hedge funds very well, but it’s often been said that hedge funds are more compensation schemes than investment strategies.
Next week, I’ll give hedge funds the attention they deserve. We don’t use hedge funds, but there are some great ones, and the strategies are often sensible, but the fees need to be appropriate as well.
