Book review: Ted Seides – “So you want to start a Hedge Fund”
Ted Seides, the author of this book came to some fame because of his 2007 bet with W. Buffett where he claimed that he could pick 5 (hedge) fund-of-fund managers which would outperform the S&P 500 over the next 10 years. He already admitted to have lost before the 10 years end.
By coincidence I found out that he wrote a book on how to start a hedge fund in 2015/2016.
The book itself is written both, from the perspective of the aspiring hedge fund startup as well as from the perspective of the “allocator”, usually some pension plan or endowment officer (or consultant) who decides which hedge fund gets money from an institution.
The book starts with a lot of famous names (Swensen, Ellis etc.) that have “influenced” the author and maybe also to make him appear more important.
Trying to summarize his major points of what makes a startup hedge fund in the US successful (my summary):
- start with very good performance
- then market the hell out of that performance
- continue to deliver great performance
- never stop marketing
- Don’t underperform
- look at your fund primarily as a “business”
- “Allocators” are very important people. Don’t waste their time as a hedge fund manager start-up
The author gives a few other tips, such as not keeping a large cash position when starting, avoiding “co-manager” structures and use more focused strategies because fully flexible strategies are difficult to explain to the allocator’s clients.
To be honest,I think I have oversimplified the points from the book, but in my opinion the book is a good summary what went wrong in the Hedge fund industry in general and the under appreciated impact of the “allocators”.
Seeing a Hedge Fund primarily as a business
The author even encourages founders to see starting a fund mainly as a business. In my opinion this creates a myriad of problems. Running it as a business, you want to increase your revenues as quickly as possible which means you need to show positive performance as quickly as possible. This in turn in my opinion leads to momentum chasing strategies with the well-known “hedge fund hotel” positions. In the long run, this behaviour is clearly not the best strategy for the actual clients. In such an environment it is very difficult to run contrarian strategies as you need to show positive alpha all the time. In my opinion, many HF managers who start succesfully with a certain “edge” lose this edge quickly when AuM increase. As assets still tend to be quite sticky, the hedge fund manager will still do Ok (with fees) compared to his clients.
Allocators as additional resource of momentum
After reading the book I realized that I didn’t really factored in the role of allocators in my understanding of capital markets. In the same way as Hedge fund managers are chasing hot stocks, allocators are chasing hot Hedge Fund managers. This basically then produces a “double whammy” to the underlying momentum stocks. On a micro basis this clearly explains why some hot stocks go so far above any reasonable valuation as money keeps pouring into such stocks, both via individual HF managers as well as increasing allocations from allocators.
“Allocators” are in my opinion an under researched aspect of the capital market. Having had such a role myself in the past I can admit, that allocation of investment mandates is important but more often than not, the decision makers (and the allocators themselves) are not really qualified.
There are clearly exceptions such as David Swensen and a few other US university endowments, but in my experience, allocators are often people who came into that role by chance or didn’t make it into a “real” asset management role. Many allocators are simple “performance chasers”, trying to put money into the best performing asset managers without really understanding what is driving returns.
If I were a allocator these days, my major focus would be if the fund manager is interested in making good returns or increasing his assets. I would stay completely clear of asset gatherers and invest only into funds which focus 100% on long-term performance. Those guy are not easy to find but worth the efforts in my opinion.
All in all, I would recommend the book to anyone who wants to get a little insight how Hedge Fund managers and allocators are “ticking”, but I am not sure if the book is really useful to start a fund. Maybe for the US market, but I am not so sure about this.
Finally a few points on Seides’ comments on why he lost the bet:
His main argument is that the last 10 years were just a “bad luck period” for Hedge funds and for sure, the next 10 years would much better. I highly doubt this (or even call this BS). The major reasons in my opinion are clearly: Fees and the issues described above with regard to “herding”, “momentum chasing” and the incentive to gather assets.