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Fri12152017

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Why Hedge Funds Fail?

Warren Buffet attributed the failure of hedge fund to its fee structure: 2% of asset under managed per year plus 20% of trading profits...it that the real reason?

We believe fee structure is not the real cause.  It is the investment strategy such as taking focus bet with leverage is the real cause.  For instance, one of the reasons that many hedge funds did badly in 2015 was due to their "bet" in Valeant Pharmaceuticals International Inc.  It was the favourite stock among the hedge funds.  32 hedge funds counted Valeant among their top 10 holdings at the end of 2nd quarter 2015, with the stock accounting for 10% of the portfolios of those funds on average, according to Goldman Sachs Group Inc, 2015-08-19 report.

What happened was the company suddenly lost 40% of its value over 4 days following accusations of fraud, delivering a blow to hedge funds such as ValueAct Holdings LP and Bill Ackman's Pershing Square Capital Management.

Many people believe that diversification generate peanut returns and as such they take on focus "bet".  Because they have a strong "conviction" in their "stock picking" and they "know" what they are "investing in"...  However, if for some reasons like in Valeant's case, they would lost big!  Thus the real cause of the failure of the hedge fund is the "focus bet" strategy and the ability to leverage (magnifying its loss) - not the fee structure per se.

Reference:

  1. MarketWatch, Mitch Tuchman, 2015-10-17, "Warren Buffet: Why Hedge Funds Fail"
  2. Bloomberg Business, Oliver Renick, 2015-10-27, "Tom Lee Says Only Ninjas Are Making MOney in This S&P 500 Rally"