There are certain ideas in finance that behave like bad sci-fi movie monsters. Whether they are born in a dark, shadowy corner of the world or produced by some well-intentioned soul, they soon take on a life of their own. Only after they’ve spread does it become clear that something isn’t quite right. Eventually, someone discovers the fatal flaw and manages to dispatch the monster before it can do any more harm.
And just like in the movie world, these bad ideas too often get sequels – someone will inevitably drag it back from the grave and release it back into the world, as though none of criticisms, counterarguments, and debunkers ever took it to task in the first place.
In the last few days, that’s exactly what has happened with a piece we thought we had lain to rest last fall – Simon Lack’s “The Hedge Fund Mirage.” His article made some outrageous claims about hedge fund returns, and sparked a great deal of debate. Our takedown was based in part on another – the Alternative Investment Management Association’s breakdown of his piece. We both found some big flaws in his work… But who ever let the facts get in the way of a good story?
Case in point – an article from Forbes today and another (from one of our favorite bloggers, Barry Ritholtz) in the Washington Post over the weekend both cite some of the dubious statistics Lack produced in his book. Both articles included Lack’s claim that hedge fund managers took 98% of the investment gains in the industry from 1998 to 2010. As we and AIMA both pointed out last year, Lack does some very strange math to reach his conclusions, including subtracting an arbitrary -3% from hedge fund returns to account for “survivorship bias,” and subtracting T-bill returns from hedge funds. In the end, all he did was prove that if you subtract several percentage points from hedge fund returns, those returns look quite a bit worse. Color us unimpressed.
Now, in Barry’s case, he’s actually trying to make a different point about slapping a hedge fund into a mutual fund wrapper and selling it to ordinary investors. We can definitely agree that this is not a good idea. Adding an extra layer of fees and targeting unsophisticated investors is not something we want to encourage. But in a world where there are real arguments against what Barry is criticizing, why go digging up the dead?
PS – Just one more thing. Is it true that John Paulson merely “got lucky”? Sure, he made one huge bet in 2007/2008 and it worked out better than anyone could have imagined. But before his home run with the mortgage crisis, he had a long term track record of 18 years with only two down years prior to 2012. Paulson isn’t the kind of manager we would endorse, highly discretionary and big drawdowns, but it’s hard for us to back the theory that he merely “got lucky” across those many years. This is really just a lesson on the dangers of investors chasing performance, which can hardly be blamed on a manager.