The rights to make future "Terminator" movies and TV shows has been purchased not by a studio or the governor of California, but a Los Angeles-based hedge fund who bought the franchise at a bankruptcy auction earlier this week.
Owning intellectual property isn’t something we normally consider when we think of hedge funds. Thanks to relentless negative media coverage and endless political smear, we’ve come to accept that hedge funds are illicit ticking time bombs, recklessly leveraged casinos run by nefarious shysters who’d destroy the entire economy if permitted to roam free.
Bernie Madoff, a common criminal whose scheme the government had ample warning about, has unfairly become the poster child for an entire industry which, truth be told, has produced superior results for years.
That’s the rub: Despite all the scapegoating and demonizing, hedge funds have posted remarkably enviable returns. Over the past 17 years the benchmark Tremont Hedge Fund Index has gained 416%, compared with Russell 1000 large-stock index (317%), Russell 2000 small-stock index (289%), gold (277%), government (276%) and corporate bonds (255%).
Comparative Asset Returns Since 1993Source: Bloomberg, Tremont, Rosewood Research
It’s worth noting that outperformance includes the fund’s incentive and management fees that the other benchmarks don’t pay.
Hedge funds and other speculative operators are often chastised as being preoccupied with the fast buck, oblivious to long term wealth creation. In a recent speech, President Obama commented how “far too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward.”
We can only wish that more financial firms would have invested in hedge funds. Examine the data and you’ll find that much of the funds’ recent success comes from avoiding the dramatic downturns in 2000 and 2008. That’s a pattern commensurate with less risk taking, not more.
Shorter-term results are also impressive. The supposedly “risky” hedge funds have, on average, gained in value since the credit crisis began unfolding at the start of 2007, a claim U.S. stocks can’t make even after a 50%+ rally off March’s low. Investments made in the “conservative,” government-sponsored enterprises Fannie Mae (FNM) and Freddie Mac (FRE) have lost over 98% of their value during the same period.
Asset Returns Since Credit CollapseSource: Bloomberg, Tremont, Rosewood Research
Normally, successful returns would prompt accolades and praise. Yet innumerable legislators have called for (even) greater control and scrutiny of funds, already subject to regulations levied on no other industry. As it is, hedge funds are prohibited from advertising or publicly soliciting business in any way. With few exceptions, they are limited to a maximum of 99 customers and can only accept investments from “accredited” investors with a liquid net worth greater than $1 million dollars. Is any other business subject to such draconian bullying?
The upshot? Our paternalistic government has succeeded in preventing the vast majority of citizens from investing in the one asset class that’s made real money over the last generation.
In an effort to bypass the regulation, a number of products have been introduced that attempt to either replicate or reproduce hedge fund returns in a mutual fund or ETF.
Launched in 2009, the IndexIQ Hedge Fund ETF (QAI) doesn’t actually invest in hedge funds, but analyzes the holdings of major funds and builds a long/short portfolio using ETFs thought to mimic that performance. Similarly, IQ Hedge Macro Tracker ETF (MCRO) uses ETFs to mimic the return characteristics of hedge funds pursuing a macro strategy based on trending global themes.
Rydex/SGI Multi-Hedge Strategies (RYMSX) uses increased diversification and risk management technique to try and achieve hedge-fund returns. Schwab Hedged Equity Select (SWHEX) only buys stocks but uses short-selling techniques commonplace at many funds to limit the effect of market swings.
A Speculative Surrogate”Hedge Fund Surrogates” QAI, MCRO, SWHEX, RYMSX – 6 monthsSource: BigCharts.com
While all offer exposures not available within most vanilla mutual funds, none sufficiently provide the varied approach of an asset class able to seek out profit, long or short, in any instrument – even films. In slandering them, publicity-hungry politicians only make it more difficult and expensive for investors of every size to make an honest buck.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC.
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