Not only was it possible to lose money, some hedge funds did. Just look at Renaissance's non-insider funds.

This is where people fundamentally misunderstand what hedge funds do. It's been nearly impossible to lose money as a long only. But hedge funds, which have massively underperformed as an industry have largely done so because the Fed has forced everyone to be maxi long risk assets. There is no alternative. And fundamentally, this isn't what hedge funds do.

I've often heard people say hedgies are just levered beta. Well, that's obviously not true as we've seen indices outperform. Some of the best long/short investors have been absolutely wrecked in the post 2008 QE environment (QEternity) because price discovery is meaningless. The Fed is in the driver's seat, and the managers who have killed it had one simple thesis: the Fed has your back, so BTFD. Front running the Fed has been the best and easiest strategy for over a decade now. And it will continue to be so until it isn't...

Can you explain what you mean here?

> maxi long risk assets

I think you mostly mean "own assets", but would like to understand this phrase precisely.

Not the GP, but I think they mean that there has been no point in hedging (hence "hedge fund") risk in the world of Fed-driven asset prices. If the Fed has your back to BTFD every time (and just look at the S&P 500 since the Covid crash -- a 30% loss was made up for in just six months), why bother trying to seek alpha to beat the market by trying to buy under-appreciated assets and sell over-appreciated ones? Just buy everything. And if you still want alpha, you just apply leverage. This last part leads to big volatility whenever there is a trigger.

Alpha should be risk adjusted (a la Sharpe/Sortino), but broadly your answer is correct. Current Fed policies punish those who don’t take risk, by design. Hedge funds (in theory - ahem) are structured to maximize risk adjusted profits. But if there’s no risk, because the Fed has made it so, then there is nothing for hedge funds to do but accept the new casino world for what it is: play along and hope that the Fed can control whatever comes our way. It’s a fools errand to hedge...until it isn’t.

Maxi long = maximum ownership that a relevant risk grid would allow

Risk assets = anything but the dollar or bonds

Basically buy assets which (they believe) stimulate the economy more by either lowering financing costs (“the hunt for yield”) or through wealth effects (“my portfolio is up 50%, I’ll spend/consume more now”)

Yea I remember reading about this in another thread: https://news.ycombinator.com/item?id=25953890

> Ray Dalio’s Bridgewater Associates and Jim Simon’s Renaissance Technologies ... each suffered negative double-digit returns in their main funds in 2020. Similarly, some of the industry’s most highly regarded names such as AQR, Two Sigma, and Dimensional Fund Advisors all suffered massive investor redemptions in the face of substantial underperformance in 2020.

RenTech finished the year up over 70% in Medallion, however.

"Despite the pandemic and everything else going on, there was no market crisis last year."

There absolutely was a crisis. Perhaps several, depending on how you break up the time period.

The crises were very short lived and did not have much long term impact but, make no mistake: the VIX shooting to almost 90, oil pricing dropping below zero and continued instability in the repo market / money market rates ... those were all crises and they were, indeed, global.

I think both articles kind of miss the point: people aren't usually allocating to hedge funds in order to earn monster return. I mean that would be nice as well, but if a hedge fund delivered about the same returns as the market net of fees but with lower volatility and/or correlation, people would be happy with that as well.

Why would anyone give more fee to basically perform like market but for less volatility?

Pretty much everyone? Return is always measured as a function of risk (i.e. volatility). For example, it's trivially easy to get twice as much return if you're willing to take twice as much volatility - just use leverage to juice your returns (and your losses). However, to get twice as much return with the SAME level of volatility is exceeding difficult (you would essentially be a Warren Buffet at that point).

Similarly, to get the same about of return with much less volatility is just as difficult. It's why people were so willing to put money into Bernie Madoff's ponzi scheme, and why his years of steady returns with very little volatility turned out to be too good to be true.

I think the word "correlation" is the more important one.

Lack of correlation can be very valuable even if the returns are mediocre to poor.

I don't remember or understand how it works, but I think I read once about how a fund manager claimed to be able to take more risk with the "long" part of a portfolio because of the uncorrelated "short" part, even though the returns of it were unimpressive.

The expected value of the sum of two random variables is the sum of their individual expected values. The variance of the sum is the sum of the individual variances plus twice the covariance.

So, if you have two different assets with the same expected value and same variance, but with zero correlation, then all mixtures of the two will have the same expected returns, but a 50/50 basket of the two assets will have 0.707 (1/sqrt(2)) times the variance of either of the two assets alone.

More generally, for a basket of non-correlated assets, a basket that maximizes expected returns divided by standard deviation of returns will never be 100% one asset. Returns are a linear function of the individual weights, but std. deviation of returns are a non-linear function. (This is true, regardless of statistical distribution of the random variables, as long as std. deviation is well-defined... no assumptions about normal distribution are involved.)

Nice writeup. The catch is it's very hard to measure correlation reliably for badly behaved random variables (like the ones we have in finances).

I've worked in the industry, and yeah is a good explanation. The problem is that there is a reason why some strategies are uncorrelated to the market ; because they are not trading liquid vanilla products. Institutional investors cannot invest in crazy stuff that easily. Renaissance and other unicorns are not always open to new institutional investors, and certainly not one with tons of compliance to deal with.

1) Portfolio size, 2) low market correlation, 3) above market performance.

Choose two. You cannot have all three.

A $40B manager once told if I could deliver 6% annual return with 1% volatility, he would give me all his money. Yeah, they want as little volatility as possible.

Because you can leverage more and earn more return for the same volatility. Which hedge funds often do (they are typically leveraged)

Because volatility drag reduces the rate of compound growth. Less volatility = faster growth = greater wealth sooner.

To allow higher leverage!

>It was basically impossible to lose money, no matter what you invested in

It's always possible to lose money. One obvious way was to say "I'm not panicking, there's no reason to panic" as the market crashed and capitulate right as it hit bottom, and spend the rest of the year saying "why is the market going up, it makes no sense, the world is ending".

It's easy to second guess yourself. Suppose you were entirely invested in biotechnology for several years prior to covid. Surely that is a good position to be in. After over a year, in retrospect, it is. But in the initial selloff, biotech crashed with everything else. Psychologically, how do you react? Do you say to yourself, everybody (the market) is wrong? Or are you conditioned to think the market knows better than almost any individual. The market was wrong as it turned out. I mean, covid treatment and vaccines are not gold mines for the private sector in themselves, thank god, but the pandemic is obviously driving and will continue to drive a realization of how important biotechnology is in general.

>their standard 2% of assets/20% of profits annual fee structure is absurd

I wonder when that became the "standard". Before I heard of the term "hedge fund", I heard of people charging 1% and 10%. Like in the early 80s.

A joke I heard (not sure if apocryphal) was someone naive asked "if you charge 10% of the profits, does that mean you give back 10% of the losses?" The answer: "Oh, no, that would be unprofessional"

> that is what hedge funds are designed for. In an era where you can buy pretty much any security for free with a few clicks, their standard 2% of assets/20% of profits annual fee structure is absurd

I don't understand, you seem to imply that any decent hedge fund makes obscene amounts of money, but if they did, then high fees would not be absurd - problem is, they mostly don't.

2/20 seems to be the standard because that's what's charged by some prominent funds, so that's what gets quoted in articles, but I don't think it was ever the fee at even 50% of funds, and it's been declining back towards 1/10.

Buffett was 0%/25% (over a 4% hurdle IIRC).

That’s what he originally had. ...Then he had a rough patch and asked his investors to switch to 2/20, so that he could keep operations running also during bad years. His investors agreed and 2/20 was born...

He never had a rough patch running the Buffett partnerships, or changed structure. He made money every year and his returns were roughly 40% annualized. Source: I’ve read the partnership letters.

And I’m pretty sure 2/20 was already a common fee structure on Wall Street before Buffett started his partnership.

> Despite the pandemic and everything else going on, there was no market crisis last year. Quite the opposite in fact. It was basically impossible to lose money, no matter what you invested in.

coughs in Wirecard, anything related to tourism, and Melvin Capital / Citadel

Jokes about fraud empires and short squeezes aside - the fact that the stock markets have prospered despite many millions of people losing whatever tiny remaining savings they had, their homes, their freedom, their jobs, their health and in way too many cases their lives is disturbing in itself. A market that decoupled from reality is dangerous.

> In an era where you can buy pretty much any security for free with a few clicks, their standard 2% of assets/20% of profits annual fee structure is absurd.

There is no such things as "buying securities for free". As a retail investor you're still paying something: your data, to offer hedge funds a way to front run your orders and to make them profits.

The market corrected around Q1/Q2 last year and this is one of the events which causes hedgies profits to soar.