What you are saying applies to vast swaths of the industry, but not all of it. Consider the track record of Renaissance Technologies' Medallion fund, which had annualized returns of 71.8% for 1994-2014 [1]. It's not all smoke and mirrors - there are some funds beating the markets consistently that are worth every bit of their fees and then some.

[1] https://en.m.wikipedia.org/wiki/Renaissance_Technologies#Med...

By definition an outlier as one of the most successful funds of all time. Also "The firm bought out the last investor in the Medallion fund in 2005 and the investor community has not seen its returns since then"

Nevertheless, it is a fund that has beaten the markets consistently. I was just saying that it is possible to do, so the entire industry is not the sham that most people think it to be. Just the vast majority of it is.

Ask a million people to toss coins repeatedly and it's likely you'll find someone who gets twenty heads in a row.

There's a lot of survivor bias in the industry. All the old players have made a lot of money at some point. If they hadn't, they wouldn't be old players.

It's a little worse than that as there are vast incentives to be that guy with 20 heads so people will record themselves fillping coins over and over then only talk about their best streak.

Thus you end up with most companies having an 'above average' streak in a given year even if the average investment does poorly. https://m.youtube.com/watch?v=rwvIGNXY21Y

But if the person who called all 20 flips properly is a math PHD who discovered the Chern–Simons secondary characteristic classes of 3-manifolds which has had a profound effect on modern physics[0] - I might think they've figured out some deep shit about coin tossing.

[0]https://en.wikipedia.org/wiki/James_Harris_Simons#Academic_a...

I know who Jim Simons is. But that sounds like an argument from authority to me.

I was citing in case anyone reading was unaware of his mathematical chops.

That's a fair point. I'm not one for argument by authority.

My point with his discovery is that he's empirically demonstrated a capability of uncovering understanding and deep mathematical relationships, which have practical implications. The PHD part is less relevant.

In my opinion, this information decreases the probability that rentech has been consistently outperforming on the basis of pure luck. By how much, though, I can't say.

There is survivorship bias, but the coin flipping analogy is a tired trope (and it implies something utterly different). There aren't a million traders, and there are more than 20 consistently beating the market. Significantly more. Do the actual math with some attempt at empirical numbers and your argument might make sense. Until people start doing that, repeating this line about coin flips and the law of large numbers doesn't add anything to the discussion.

First of all, you haven't qualified who you're including in the set of "traders" and who you're including in the set of "winners." Is everyone who signs up for ETrade included? That's like major league baseball players being judged the same as way as high school baseball players. More importantly, have you done the cursory research to account for funds that consistently beat the market? How do you account for the firms that beat the market over periods that span decades? Just ridiculously lucky? What counts as a coin flip? A single trade? A trading day? Are the coins summed per trader or per fund? How are we quantifying this assessment?

It's like every time someone brings up the coin flipping analogy they use these outrageous numbers without any attempt at citing a grounded source in reality. As I say every single time in threads like this: yes, it's incredibly difficult to purposefully and consistently beat the market, but that's worlds away from impossible. There is information asymmetry in the market, relatively few people/firms are capable of identifying alpha based on that, and fewer still are capable of capitalizing on it. But they exist!

Stubbornly repeating the coin analogy is like insisting on proof that basketball players have inherent skill instead of luck, because most people can't make it to the NBA. We have clear examples of firms beating the market consistently for decades at a time, net of fees. I am personally familiar with people whose strategies profitably trade on small pockets of predictable events in timeseries tick data. Their strategies are smaller (~high 6 - low 7 digit accounts using personal capital), but they consistently earn 27-30% each year by trading strategies that are too capacity-constrained for larger firms (and usually they do this after being in the industry for some time).

I make this point not to pick on you (it's not personal!), it's just that I see this repeated in every thread related to trading on HN. Referring to trading as coin flipping when your familiarity mostly stems from news reports flies in the face of people who are capable of developing profitable trading algorithms and who have seen it. It's as if someone told you that it's impossible to develop well-engineered software. It's exhausting. There's this weird leap from (correctly) concluding that most people in the industry can't beat the market, to damning the entire concept.

If you want to say there is a lot of survivorship bias in the industry, sure, I'll agree with that. But what's the point of using Fama's coin flipping analogy if there's no rigor behind it? It precludes so much nuance in fund performance. Many funds can't beat the market at all. Many do beat the market, but they purposely decide to eat away all those gains with fees when they could run a far leaner ship. And the elite do consistently beat the market, until they eventually get large enough to diversify into multiple funds (accepting that most will be mediocre) or they return investor money because they don't need it and their strategies are capacity constrained.

Ok, fair enough. The coin flipping analogy isn't great. But it's a pithy way to make a very valid point: there's a massive amount of luck in investment. To see this, let's think about coin flipping again :).

Suppose I have a 90% chance of making a positive return in any given year. The chance that I'll make money every year for ten years is about 35%. Over 20 years, it's about 12%.

Now, I don't believe that anyone has a 90% chance of making money in a given year. Even if I conceeded that it's possible to have a long-term edge in the markets, I'd say it's more like a 55% chance of making money. So instead of there being a handful of elite geniuses with a 90% edge, I think it's more likely that there are many smart people with a 55% edge, all tossing coins.

I've hidden a lot of things away in this analysis, and I'd need to write a full essay to give the issue its due. For example, I've ignored the possibility to "beat" the market by leveraging up your S&P exposure and charging fees on top. If the S&P goes up, you beat it. If the S&P goes down, you blow up and start again.

What you say might be right. But there is the purely ontological question (do traders exist that outperform consistently?), and the different pragmatic question: Does it make sense to part with my money and give it to active asset managers?

The answer to the theoretical first question might well be "yes, there are exceptional traders outperforming the market". The second "real-world" question is much more involved:

* can I reliably identify them, ex ante? That's pretty hard.

* do I have access to them? Many of the examples cited (Renaissance Tec, individual traders trading personal account) are closed to outside investors. Many golden investment opportunities are channeled to people that are very well connected (either in the finance industry, or old money, or close to politics). Similarly, there might be legal access restrictions - you must be a qualified investor, or reside in a certain jurisdiction, etc. etc.

Personally, I think most of the asset management industry is basically a giant rent seeking exercise, charging extraordinary fees (over the long run) for very little value. There are exceptional performers, but they are not accessible to most people. (As a side note, much of their exceptional performance might come from insider information more than exceptional analysis.)

Thus, the standard advice stands: put most in cheap index funds/ETFs, and maybe develop some expertise in certain areas and dabble in it with a fraction of your assets, if you're so inclined.

The reasons that the finance industry is particularly prone to unproductive money skimming (rent seeking) include:

* massive information asymmetry (similar to real estate)

* psychological biases (most people don't realise that someone taking a tiny 2% fee per annum has basically taken half your savings by the time you retire)

* mostly experience goods (or even post-experience goods): enormous difficulty of evaluating quality ex ante, or sometimes even ex post (your pension pays you X per month. Could a competitor have done better?)

* regulatory capture

etc.

The coin analogy is a perfectly legitimate parable to highlight how difficult it is to evaluate asset manager performance. Sure, the actual analysis then still needs to be done, but the outcome, from what I can tell, remains pretty damning.

> The answer to the theoretical first question might well be "yes, there are exceptional traders outperforming the market". The second "real-world" question is much more involved: > * can I reliably identify them, ex ante? That's pretty hard.

The answer to question one, as you say, is yes. If it was purely coin tossing any group of performers would get halved each year (let's not mention skew). Now there are funds that fall quite hard, like Odey. But it's clear there are funds that seem to defy gravity.

Question Two. Here's how I decide if I believe in a fund.

Here's a real life example. A friend of a friend came to a meeting and explained that under certain circumstances, you can buy certain unit trusts cheaper than they're worth. You need to dig out the nitty gritty details of each fund: the holdings, the rules, the fees, trading regulations, and so on. You put all this in a computer, which tells you when there's a mispricing. You need good relations with various counterparties, or you won't get the trade. And you can only do it up to a certain scale, because there's only so much mispricing. And it's sensitive to costs, so you need his particular cost agreements.

This also explains why you'd have to invest in this particular guy. He has the infrastructure and relationships already in place, so even if you knew his method, you couldn't do it yourself.

You're right about a lot of funds being smoke and mirrors though. I used to run one, and the investors never ask the right questions. Mostly they chase returns, but they don't even know how to tell the difference between one track record and another. It makes a huge difference how they're generated, yet most questions are simply trying to put you in a category, like produce in a supermarket.

> You're right about a lot of funds being smoke and mirrors though. I used to run one, and the investors never ask the right questions.

Wow!!!!!

I've never heard an owner of a hedge fund refer their fund as "smoke and mirrors". I really hope for your sake that you just misspoke.

I'm sorry it didn't work out for you. I understand how hard the industry can be, if you ever think of trying again, don't let your past failures dissuade you.

I'm available to chat if you'd like:)

We've already spoken, well emailed. I'm doing prop for an HFT, not a million miles from running a fund. Well, it's better anyway.

As for smoke and mirrors, naturally I mean other people's funds! Mine actually would have won the bet with Warren by a fair margin.

Come to think of it, I was a partner before that in a fund that wasn't so good, but had lots and lots of investors climbing over each other to invest.

> the investors never ask the right questions. ...

> most questions are simply trying to put you in a category, like produce in a supermarket.

Yeah, and who can blame them? It's very hard unless you have an inside edge. And lamentably many funds cater to those investors, put out nice and shiny brochures, and get good amounts of money to manage.

The coin flip being tired or a trope is irrelevant. The million and 20 may not even be correct (haven't checked). the point is that people see patterns even where they don't exist. That's why science has methods for telling whether a pattern really represents something or if it would likely be seen even if the data were random. Until you do those stats on hedgefund returns your irritation at the trope remains unconvincing.

I suppose we're at an impasse then, because the claim wasn't mine; nor is it even sufficiently formalized as to be falsifiable (which really was my point here). We cannot apply scientific methods to claims that are only semantically meaningful. For example, the definition of "coin flip" was never even specified, which is why the constant use of the analogy is absurd.

When firms like RenTec exist and continue to empirically generate market-beating returns over 20-30 year timespans, the burden ceases to be on the critic of a claim to empirically disprove it, especially if it's not even falsifiable. Here, you are doing the same thing as the previous commenter, except you're not using the analogy.

You cannot open your argument with the premise that returns are purely stochastic if that's not self-evident - you need to prove that. But I have never seen a single individual attempt to quantify the analogy, not even in a forced way to make it support their thesis. It's taken for granted that superlative returns are purely chance, and the goalposts are constantly moved whenever someone brings up successful funds.

I understand you have declared we are at an impasse so I will just take the "last word". Your second paragraph is mere assertion. I assert the opposite. The existence of extreme outliers is exactly what we see in statistical distributions all the time. Being able to identify them in retrospect is childs play.Doing it in advance is the trick. That fund very likely does have great skills and plans at work that happen to have been met with circumstances that made them work. Yes you can attribute that to skill.

All posters are more or less right in this comment chain, but talking about coin flips and renaissance in the same breathe _seems_ to be silly, if you've read about the latter. (Not an expert so I might have been mislead by what I've read...)

> it's impossible to develop well-engineered software

That doesn't sound so stupid.

It does to people who've done it consistently.

And if it were really like coin flipping, wouldn't the average industry profit be zero?

> Consider the track record of Renaissance Technologies' Medallion fund, which had annualized returns of 71.8% for 1994-2014

Kind of a side point but I don't see how this can be true. Wikipedia says Renaissance had $65 billion AUM as of 2015. If we back-track this compounded at 71.8% annually, that means Renaissance must have had at most $1.2 million in 1994, which is implausibly low. And $1.2 million is a maximum, because that figure assumes Renaissance hasn't received any new capital since 1994.

The fund has a very low cap and their employees can only put in a certain amount in the fund in the first place (depending on seniority and individual performance).

Also, you're assuming everyone who's put money into the fund has never taken it out, which would throw off your math quite a bit.

Medallion fund is said to be about $10B, and at capacity - that means that returns don't compound, because they pay out the profit each year as they can't invest any more money.

You're confusing RenTec with the Medallion fund, which it manages. RenTec manages other funds as well. Their AUM is the sum of the assets of the funds.

It's slightly different when you get into the range of millions and billions of dollars. If you're investing 100,000, you're better off with an indexed mutual fund that charges .03%. If these funds can consistently return 10%, that is actually better than what index funds can get you, which is more like 7% on average over the course of decades, but with a lot of year-to-year variation. But then the expense ratio is 3.6% so the hedge fund clients only get 6.4%... but if that's consistent, it's a pretty decent return.

Warren Buffett put his money where his mouth is: he won his $1m wager on the S&P 500 beating a basket of hedge funds over 10 years. And he won despite buying the S&P right before the great recession -- you'd think the hedge funds would have thrived in that market crash by "hedging". It's one more proof point that the vast majority of hedge funds are more risky than justified by returns, regardless of the amount.

The salient caveat here is that Buffett's bet was against "fund of funds", not individual hedge funds. I would have happily taken the other side of that bet if it was about individual funds and I was allowed to choose them (Buffett also would have lost in that case, but to be fair it would be a fundamentally different claim to bet on). I'd make such a bet even today.

I don't disagree that most hedge funds are poor investment vehicles, but that's the nature of active investing. If the majority of hedge/mutual funds underperform the market, and you choose to invest in a fund of funds (essentially an index of their net performance), it doesn't really take a $1M bet to see who is going to lose.

I don't think Buffett would take a bet he didn't feel extremely confident about winning, but Ted Seides was just foolish. The only rational reason I can see for taking the other side of the bet given its terms was to generate publicity for himself and his own fund at the expense of some reputation a decade down the line. If he profited from that, I guess it was worth it for him. I really can't imagine he seriously believed he'd win.

This strikes me as typical gambler mentality. I'd definitely bet against you. I saw your post above about skill and I agree there are people who have better skills at this. The problem is they are operating against a chaotic system. Their way of doing things may get huge returns consistently...until it doesn't.

This is 110% true: "Their way of doing things may get huge returns consistently...until it doesn't."

And most people will never fully understand that until it happens to them. Then you have this eye opening moment, and you understand.

Sure, but when that moment happens over 20 years after you've started your "way of doing things", and you've amassed a giant fortune in the process, your eye-opening moment is not, "Well, I guess I was lucky all those years." Your eye-opening moment is, "Well, it's time to retire my strategy and change my methodology, if I can."

Nothing lasts forever. Conditions change in every arena of competition, not just the market. If a professional basketball player is incredibly successful until their bodies literally begin to degrade, do we raise philosophical questions about the inherent attribution of their skill?

People don't seem to respond well to the quant fund examples, so how about this - how has Warren Buffett consistently beat the market through Berkshire Hathaway? If he ceased beating the market this year, would it because he has been lucky all these years? Would it be because the market conditions that supported his success have fundamentally changed? If so, why does that indicate his performance was due to chance?

> People don't seem to respond well to the quant fund examples, so how about this - how has Warren Buffett consistently beat the market through Berkshire Hathaway? If he ceased beating the market this year, would it because he has been lucky all these years? Would it be because the market conditions that supported his success have fundamentally changed? If so, why does that indicate his performance was due to chance?

People were asking this back during the dotcom boom, when he lagged the market by a huge percentage.

Gotta wonder how many Warrens were unlucky enough to have this happen early on in their careers.

As with many high performers he did it by fantastic returns at some point. I just looked up his returns in a business insider article and a quick calculation indicates that although someone who invested year one got rich, his returns over the past 30 years average to 6% (by my calculation- willing to be corrected)

I recall reading a stock book back in the 1980s that claimed that Buffet's legendary status at the time was entirely due to his purchase of Geico

Would you like to make a bet on longbets? I'm game.

Ok stranger on the internet :). How about this. You pick 20 hedge funds. If over the next 20 years they return more to investors after fees and such than the Vanguard S&P 500 Admiral fund you win, otherwise I do?

I'd even let you change your list Jan. 1st of each year as long as we agree that any hedge fund found to be a fraud of some kind counts as a zero in your sum.

This is actually a pretty good bet for you given how poorly one would expect stocks to perform over the next 10 years

If you'd be willing to take that Buffet bet using a fund that you choose, then why not instead just pour all of your own money into that "sure thing" fund? Maybe you have, in which case I applaud you for putting your money where your mouth is.

I would be happy to put my money where my mouth is, which is why I trade with strategies I have developed. If those funds were accepting outside investors for less than 8 figures, I would absolutely invest in them. But the reality is that many hedge funds that achieve that sort of consistent capability soon stop accepting investor capital due to capacity constraints, which leads to a different sort of issue than those returns being fundamentally impossible.

> If these funds can consistently return 10%

Well, yeah, that's the point, isn't it? I thought these funds can't.

Some of them can, have and do (e.g. Point72, Renaissance, Soros, et cetera). This extends to many more funds [1]. Furthermore, some institutions (e.g. Yale) are consistently good at picking those funds [2].

The average hedge fund seems to eat all its excess returns in fees. But around a third of all hedge funds, mostly upstarts, die in the first few years [3].

By analogy, if you can understand that Kleiner and Google create excess returns while most VC funds do not, you can understand why a similar exponential dynamic is at play with hedge funds.

[1] http://www.investmentreview.com/files/2009/12/18-241.pdf

[2] http://m.pionline.com/article/20141222/PRINT/312229982/big-p...

[3] https://www.forbes.com/forbes/welcome/?toURL=https://www.for...

Great response. I personally agree with Point72 but avoid using them as an example. In my experience it attracts the argument that their returns are illegitimate due to illegal insider trading, which draws the focus away from others like RenTec and Soros.

I don't think that the statement

Hedge fund returns average the same as passive equity

Implies that you should never invest in a hedge fund, because it's possible that they have individual characteristics which mean that they're more or less likely to fail, which you could notice when you invest. eg. Management is obviously incompetent, no track record, incoherent strategy, track record based on being long in a rising market etc.

If you believe that's the case, then you might still get above average returns by doing your homework.

But I guess given that assumption, still only worth it if you have enough money that you're completely able to lose that it's worth you spending the time to try and work out which hedge fund you trust (easier than spending your working days trading yourself).

So if you're an educated hnwi, maybe. If the chain is like you => your employer => your pension fund => some advisor => hedge fund, I'd guess not.

I don't have any evidence for this it's just what I believe.

Depends you might want to preserve capital and not try and shoot the lights out and use a hedge fund /active fund that is designed to do that RCP in the uk is one example.

Hedge funds are not open to Joe public rather only the accredited investors. From wiki - "Generally, accredited investors include high-net-worth individuals, banks, and other large corporations,".

The high-net-worth bar is lower than you might think. $1m in non-first home assets or $250k in income. Your dentist is not necessarily financially sophisticated by virtue of their high wages.

Are there no listed hedge funds you can invest in and could you not just buy shares in LSE listed hedge funds?

Pershing Square for example is an obvious choice on LSE and is an arbitrage play as it looks like it will join the FSTE 250 and have to be brought by index funds.

In a larger sense, it's about persuading Joe Public that this activity is in any way useful.

I think the main skill is probably parting clients from their money (convincing them to give it to you), not actually investing the money well. Marketing, essentially. If you can sell, you make money.

same could be said of venture capital