Hedge funds have come under a lot of criticism in the past few years because of their poor performance, headline risk and high fees.
Some of this criticism is warranted — it comes with the territory when you charge premium fees — but people also tend to forget that hedge funds are not an asset class, they are an investment structure.
Even with the poor performance of most hedge funds during the latest cycle, there are still many good lessons we can take away from them from a business perspective. When I met with hedge fund managers and their teams in the past I would always come away impressed with how they were run from an operational standpoint. There’s a reason the industry has almost $3 trillion in assets.
Based on my experience, here’s what hedge funds get right:
Their sales and marketing materials are unmatched. These people know what they’re doing. First of all, it’s nearly impossible to walk away from a conversation with some of the best and brightest hedge fund portfolio managers and not be impressed. They have a way of making you feel like they’re doing you a favor by giving them your money to invest, and not in an underhanded way.
For the most part these are brilliant people who are great at selling their brand. Also the sales and marketing teams at these funds are top notch. The best funds would hand you a due diligence questionnaire that basically answered every question you could think to ask about the firm, the investment process and their operations. And their pitch books were always the best-looking, most professional marketing materials out of anyone.
They invest heavily in technology. Most large funds I talked to employed as many or more people on the technology side of things as they did in portfolio management. The computing power, research and databases some of these funds commit to is quite impressive and usually far ahead of most other firms in the investment business.
They have the back office covered. During the 70s and 80s the hedge fund industry operated like the Wild West in many ways (read More Money Than God for more on this). Then in the 90s and 00s institutional investors made a huge push to invest in hedge funds. These large pools of capital are very demanding about what types of firms they will and won’t invest in so hedge funds had to really beef up their back office and operations staff to appease the large pensions, endowments and foundations.
Institutional investors want all of the right legal documents, someone to help them with their audit and legitimate third part administrators for their statements and valuations. The largest funds now have an impressive operations department, the very best lawyers, as well as fully staffed risk management teams full of PhDs. The funds that don’t make it big, even with great track records, are often the ones who can’t figure out the business side of the equation and get their operations in order.
They hire some of the best and brightest. Reading through the biographies of these funds is a great way to make yourself feel like you’ve never accomplished anything in your life. From the top on down almost every single employee attended the best colleges and universities on the planet. Their resumes are flawless. These are some of the most competitive people in the business world.
Going to an Ivy League school doesn’t promise you anything in the markets (and you could even argue that at times it’s a hindrance), but you would be hard pressed to find a more highly educated workforce than what most high level hedge funds produce. I also know from talking to people in the industry that getting a job and making it through the grueling interview process to work at a hedge fund is not easy.
They keep their clients interested during periodic communications. There’s a reason most hedge fund managers ask their investors not to share their quarterly letters with other investors or the media (yet somehow they always leak) — they’re really well-written, thought-provoking and offer interesting investment ideas. Obviously, they’re not always right, but hedge fund managers consistently put out some of the best market updates of anyone.
Most investment firms follow the same template for every single client letter — talk about the Fed for a bit, go over the latest macro headwind and then show how the market performed. There needs to be a little more creativity and information divulged to keep your investors interested. Hedge funds are masters at this.
Further Reading:
Why People Invest in Hedge Funds
Now here’s the stuff I’ve been reading:
- Why is Bernie Sanders missing the trend in financial services? (A Teachable Moment)
- Shared delusions between investors and money managers (Research Puzzle)
- There are no shortcuts in evaluating your risk tolerance (NY Times)
- Not all smart beta funds are created equal (Irrelevant Investor)
- Why aren’t there more women in finance? (Big Picture)
- The problem with investor inertia (Backcourt Report)
- A dozen famous lines about investing from the movies (25iq)
- The Bernstein Curve (Abnormal Returns)
- Are you the gambler or the house in the market? (Investor’s Field Guide)
- How to enjoy like like a billionaire (Monevator)
- What’s next in computing? (Chris Dixon)
- How being present increases your charisma (Mindful)
