Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [26]
The easiest way for a hedge fund investor to make a small fortune is to start with a large one. If you are an accredited investor and you are bound and determined to ignore caveat emptor, no one will stop you. Besides, it can be thrilling. But the thrill you experience when you detect a glint of mica—fool’s gold—feels as real as if you had actually struck gold. In the world of hedge funds, there is much mica and little gold.
Theoretically, a hedge fund allows investors to invest in ways that would be difficult on their own. It can amass the funds to make a run at the equity of an undervalued company and take the inevitable regulatory heat. It can study thousands of technical charts to look for a market anomaly and perhaps find an “arbitrage” opportunity. It can take large loan positions in interesting ventures. Theory rarely works out in practice.
When I met Warren in 2005, six of the top 25 highest paid fund managers achieved only single-digit returns, and these are the “successful” hedge fund managers.Yet Edward Lampert of ESL, one of the “sickly six,” earned $425 million in 2005. The top two earners, James Simons of Renaissance Technologies Corp and T. Boone Pickens of BP Capital Management, respectively, earned $1.5 billion and $1.4 billion. Renaissance’s chief fund charges a 5 percent annual management fee, and the managers take 44 percent of the upside, if any exists. In 2007, Jim Simons, Steven Cohen, and Kenneth Griffin each earned over $1 billion.9 Warren Buffett and Charlie Munger each earn a salary of about $100,000 per year, yet their long-term track record has topped these hedge fund managers.10
Many hedge fund managers got into the business because of the incredible success of the legendary Paul Tudor Jones. Tudor Investment Corporation’s $5.7 billion Raptor Global Fund, managed by James Pallotta, had 19.2 percent annual returns since 1993, but when it stumbled a little on U.S. equity investments dropping 8.5 percent by the beginning of December 2007, investors pulled out $1 billion. It is unrealistic to expect that any investment, particularly a hedge fund, will always have a positive return relative to the market. Paul Tudor Jones has had a very successful investment run since 1980 with never a down year until 2007.11 Yet even he does not represent that his funds are safer than the market. Every new hedge fund manager wants to be the next Paul Tudor Jones, George Soros, Jim Rogers, or Ken Griffin. Like Warren, there are true stars who outperform the hedge fund averages, but Warren may sleep better at night.
There is nothing wrong with making a big bet, but one cannot be lulled into thinking that investing in hedge funds is safer than the market. The strategies are so variable that some funds pose much more risk than others. The best can give high performance with few stumbles. Investors may find, however, that at best they have paid high fees to invest with a pale imitation of greatness or a clueless rookie. At worst, they may invest with a crook. Hedge funds have the potential not only to have a zero return—no increase in your capital—for a year, they have the potential to completely wipe out your capital. When you are trying to compound returns, it is fatal to multiply your capital by zero.
I run a hedge fund. My strategy? It’s a proprietary secret. Domicile? It is located onshore in the United States, but the investments are global. There is no lock-up or waiting period for withdrawing an investment from my fund. At the moment it is not leveraged, but sorry, you are not entitled to even that much information.
You won’t find my fund’s returns reported as part of a hedge fund index. Hedge funds do not have to report their returns. You won’t find my fund covered in the financial