This week it was reported that Tudor Investment Corp., one of America’s most expensive hedge funds, will be cutting its very high fees from 2.75% of assets and 27 percent of profits to a still very high 2.25% and 25% respectively. Still much higher than most of the confiscatory fees one will find among hedge funds. After hearing this I recalled what Dick Young wrote in his Intelligence Report a couple months ago, Hedge Funds Fail.
Hedge Funds Fail
Given the above, it was with some astonishment that I read Tim Martin and Rob Copeland’s recent Wall Street Journal exposé “Investors Pull Cash From Hedge Funds as Returns Lag Market.” “Lag market” is being kind. As the article explains, hedge funds have now lagged a “traditional mix of stocks and bonds for six straight years.”
2% and 20% of Profits
Rubbing salt on the wound is that hedge funds traditionally charge pension funds greedy and unrealistic fees—2% of assets under management and 20% of profits. As a basis for comparison, a diversified stock portfolio over many cycles might provide an average gross 10% annual total return (6% return from capital appreciation and 4% from yield). But layer on an anchor of a 2% management fee and a 20% fee on profits, and gross returns are slashed by a startling 40%, to only 6%. Look, investing is a zero-sum game. Each transaction includes a buyer and seller. One—never both—will be a winner, which means at least 50% of a given group of investors ends up as underperformers. And that is before the addition of usurious fees.
I Became a Former Trustee
Three decades ago, when I was a trustee at a major business school, I stood out like a sore thumb because of my opposition to hedge funds. And perhaps not shockingly, I soon became a former trustee. Well, 30 years later, I would still cast the same vote for the same reasons I have just outlined. You could argue that maybe I’ve not learned much over the decades, but my 50-year track record of generating few sizable portfolio losses proves otherwise.
My Prudent Man Rule
So I do not condone most hedge fund tactics, and I do not suffer the debilitating level of fees outlined above. Rather, I practice the Prudent Man Rule of investing and tightly follow my long-time theme of patience, time, and compound interest. Can this effortless investing strategy really create millionaires? Well, for illustration, I’ll give you a little basic arithmetic and let you be the judge. My overriding goal here is to make absolutely certain you come away from reading this issue with a whole new and profound appreciation for the two most important words in the investment universe—compound interest.