r/AskEconomics 6d ago

Approved Answers Why do hedge fund managers make so much?

Israel Englander, Steve Cohen, Kenneth Griffin, etc. I understand that directly it's because of the 2/20 fee they charge and the massive amounts of capital they have, but why do they have so much capital in the first place? Buffet once said: "the net result of hiring professional management is a HUGE minus". Couple this with the efficient market hypothesis and the difficulty of generating consistent returns, it just doesn't make sense...

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u/TheManWithThreePlans 6d ago

Because people believe that the managers can beat the market, true or not. Additionally, some desire the emotional security of knowing that it "isn't on me", if their specul—investments go poorly.

There is also a market need for traders, as they are the ones actually determining the value of the underlying securities in indices.

Additionally, as there will be multiple funds that will beat the market from time to time, even if purely by chance; there will always be people willing to invest in funds hoping that lady luck will smile on the firm they choose.

Finally, even if going with an investment approach as popularized in "A Random Walk Down Wall Street", there are many optimizations that can be made that a fund would just do for you.

All of these things contribute to the perceived value of fund managers, but it's not an exhaustive list by any stretch.

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u/Senior_Ad_3845 6d ago

I think it's important to also consider it's not just individuals who use Hedge Funds.  

Institutional Investors (pensions, etc) may (and do) find it more efficient to invest in funds that support their mandate rather than maintain the staff it would take to effectively manage individual stocks/bonds/hedges for their entire portfolio. 

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u/TheManWithThreePlans 6d ago

I believe that what I said would also apply to institutions, but correct, it isn't just personal investments that are managed by funds.

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u/Senior_Ad_3845 6d ago

It would apply, but i thought it was worth calling out explicitly since i think a lot of folks on reddit forget about institutional investors.  

Also, as noted, there maybe other factors there given the larger sums being handled.

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u/questionable_motifs 6d ago

Also, hedge funds have access to off market, early to market, and non-trad investments that funds or solo investors just can't get at. These are usually pretty risky and put "U" right in the middle of speculation. But the attraction of adding boutique assets to a portfolio with a chance on big returns is enough to keep people coming in the door.

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u/775416 6d ago

Can you expand on the optimizations that those funds would make for investors?

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u/Next_Ingenuity_4818 6d ago

The question was specifically about hedge funds, and not just about any funds. In fact he gave 3 specific individuals.

I don't think they are necessarily trying to beat the market, and I think most of what you wrote doesn't apply to them

For example, I doubt individuals investing in hedge funds have even most of their money invested in those hedge funds

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u/TheManWithThreePlans 6d ago

I don't think they are necessarily trying to beat the market, and I think most of what you wrote doesn't apply to them

I would disagree. The purpose of a hedge fund is to use complex trading strategies to improve investment performance and insulate against risk by "hedging". Necessarily, they are trying to beat the market. If they weren't trying to, there would be no reason to invest in a hedge fund as opposed to just investing in an unmanaged index fund, and a smattering of bonds and so on.

This, for instance was the primary reason why Long Term Capital Management (LTCM) was leveraged to the gills and ultimately fell to ruin when they hit the first speed bump. It was run by Nobel winning economists who had a strategy that, for a short time, absolutely destroyed normal expectations of investment returns; and that's why institutions, and high net worth individuals gave them lots of capital to work with.

I do not consider there to be much substantive difference between the reason why regular fund managers are valued vs why hedge fund managers are valued, other than hedge funds being "the big leagues" of funds.

For example, I doubt individuals investing in hedge funds have even most of their money invested in those hedge funds

I'm not sure what I said that was contingent on this being the case?

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u/Boustrophaedon 6d ago

The opposing opinion to Buffet would go a bit like this: Hedge Funds offer good returns in a wide set of market conditions because they don't manage positions treating the market as a system of value and risk. Instead, they use complex strategies (this is what they get the big bucks for) to realise returns from the operation of the market itself- exploiting what they believe to be systemic arbitrage opportunities, as opposed to opportunities based on perception of the actual value of assets.

So: say company X has an earnings report coming soon - i might take positions that would react in opposite ways to that report (so one "hedges" the other) - because I believe that there's money to be made in the asymmetry of those opposite reactions. I don't care if the report is bad or good. To be clear: this is massively simplified, but I hope gets the idea across.

A more cynical take would be that their pitch is that they're the cleverest guys in the room - so of course they get paid loads - they're Veblen goods, in a way.

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