Confessions of a Hedge Fund Manager

Are we worth it?

An expensive acquaintance

In early 2006, I was at the wedding of a good friend in the home town of

his bride outside Chicago. At the reception I sat next to the bride’s charm-

ing aunt, Mrs Straw. Mrs Straw had lived in the small town all her life and

her husband was a couple of years from retiring from the local sub-supplier

for one of the Detroit auto companies. She had not worked for a decade.

Soon the conversation turned to what I did for a living.

‘I work at an investment management company,’ I said.

‘Oh, interesting. Like a mutual fund?’ she asked.

‘Sort of. It’s called a hedge fund but it is quite similar in many ways.’

‘I know what a hedge fund is,’ she said, slightly offended that I had

assumed she would not. ‘We’re invested in them through my husband’s

pension plan at the plant. They’re great. He is so close to retiring and the

pension manager told the folks that hedge funds were like a guarantee

against markets going down.’

‘Sort of like a sure thing,’ I suggested. ‘Which funds are you invested

with?’

‘I think they invest in a couple of what are called funds of funds who are

then able to pick the best hedge funds,’ she said.

‘That’s great,’ I said, before moving the conversation on to other things.

The brother of the groom, who had given up investment banking earlier

that year, had observed our conversation from across the table. ‘Dude,’ he

said later, ‘everyone’s in hedge funds these days. It’s the way of saying “I

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158 On t he front line

am a sophisticated investor” even if many people don’t have a clue what

hedge funds actually do.’

The following morning, as I was waiting for Puk to get ready for the

post-wedding brunch, I absentmindedly

jotted down some figures on the notepad

by the bed while watching some basket-

ball highlights. These were numbers I had

known about for a long time, but never

really focused on or added up from the

perspective of the ultimate end inves-

tor. They went like this: pension-fund

adviser 0.25 per cent, pension-fund fees

and expenses 0.75 per cent, fund-of-funds

management fee 1 per cent, and so on.

‘There are a lot of people who need to get paid here before my friends

from last night see a penny,’ I thought, increasingly aware of the staggering

aggregation of fees. I would cross out many of the fee levels and make them

lower so that the aggregate fees would be more reasonable.

‘Surely external pension fund advisers only charge 0.15 per cent per

year,’ I would mutter to myself.

Still, my conclusions were troubling, and I began to think the only way

the numbers made sense for them would be if the hedge funds all per-

formed brilliantly every year – which clearly wasn’t the case. Typically, Mr

Straw’s pension fund would have its own set of expenses and fees on top

of the external adviser often hired to assess what to do with the hedge-

fund allocation. With the help of this adviser, Mr Straw’s pension fund

would typically make an allocation to one or more of the larger funds of

funds, depending on their risk appetite and their views on which fund of

funds showed greatest promise. The fund of funds selected would then go

about its work and decide which hedge fund to invest in, including funds

like Holte Capital. That is a lot of mouths to feed, particularly when you

consider that the hedge funds, on top of their typical fees, have expenses

associated with trading and administration. Below is a summary of all the

annual fees and expenses Mr Straw could incur before seeing a return from

his hedge-fund investment:

These were numbers I had

known about for a long

time, but never really

focused on or added up

from the perspective of the

ultimate end investor.