The Hedge Fund Casino (“Vegas, Baby!”)

Las Vegas Elvis impersonator having fun

An article in Bloomberg yesterday announced that Citadel hired a quant group from a shuttered hedge fund, Hutchin Hill Capital. Citadel is known for making hires from failed hedge funds. But why hire people from a fund that was going ‘OOB’ (“out of business,” as an old friend and I used to say about neighborhood places in Lincoln Park)?

One way to understand hedge funds is to realize they are – quite obviously – not about superior investment performance. Most hedge funds … well, they suck. They charge enormous fees to deliver performance that consistently underperforms passive (and super inexpensive) index funds.

As I’ve written before, my kids (kindergarten, 4th grade, and 7th grade) like to keep their 529 savings in S&P500 index funds. And they’ve crushed Citadel and most other hedge funds most every year since doing so. So … grade schoolers, on one hand … geniuses (and they really are) on the other hand … and … grade schoolers win, while playing soccer and field hockey and playing with American Girl dolls and not giving a thought to stocks all year.

But there is a difference between my kids and hedge fund investors: my kids are in it to win it. They have big dreams for their educations. Money matters to them. They want PERFORMANCE. So they invest passively.

But the Harvard and Yale endowments? The Illinois State Teachers Retirement System? Middle Eastern sheiks and Russian oligarchs? They want something else. They want to go to the shiny casino. And hedge fund managers are great at building casinos.

People go to casinos because they think they can make some easy money. And, gosh darn’t, they are so shiny:


Hedge funds build their casinos differently: hiring lots of people with a proven inability to beat the market, but who look so darn smart:

trading desk.jpeg

Let’s say the guy on the right has a Ph.D. from Berkeley in Statistics and the guy on the left has a maths Ph.D. from Harvard. How could they not beat the market? I mean … math is hard, right?

If you are a hedge fund investor, you are most likely falling prey to the shiny lights and pretty things the hedge fund managers like to dangle in front of you. “Quants”, “Algos”, “HFT”, etc. Those are the Elvis-impersonators and Gold Fountains of Hedge Fund Land.

The proof is in the pudding. And that pudding has tasted pretty awful for a long time.

You don’t want to be this guy.

If you are managing other people’s money, think about what you are doing. Are you confident you are satisfying your fiduciary obligations?

If you are investing your own money, have fun! But don’t confuse gambling for entertainment with investing intelligently.

And remember, what’s paid in Hedge Fund Land, often stays in Hedge Fund Land.



Are You The Dumb Money? Chapter 2: Hedge Fund Investors 2017


Back in January, Hedge Fund Research reported that hedge funds gained “+8.5 percent, the best calendar year performance since 2013[.]” Equity funds returned “+13.2 percent, the strongest calendar year since the Index returned +14.3 percent in 2013.”

We scratch our heads a bit at this. After all, our S&P500 Index Funds earned over 20 percent last year, and we had full-time jobs doing other things. Let me say that again: the average equity hedge fund earned 13.2%; my three grade school kids put their 529s in the S&P500 and didn’t think about it again and crushed those funds.

We learn from Reuters that “Greenlight Capital, run by David Einhorn, ended the year with a 2 percent gain[.]” Wait, seriously? (note: he was down more than 5% this January alone, proving that being a really bad hedge fund manager is still a better gig than doing most anything else.)

Crain’s Chicago Business says “Citadel, the biggest hedge fund company in Chicago, delivered returns of about 13 percent to investors in its flagship funds last year—not bad by hedge fund standards, though still far short of the S&P 500 Index’s explosive 19 percent gain for 2017.” (the Crain’s number doesn’t include index dividends, making Citadel’s return look better by comparison than it was.)

Let’s put it a different way. Last year, investors in Greenlight’s funds could have put $10 million into the Vanguard S&P500 on December 30, 2017, then sold it on January 27th, 2018 (less than a month) and sat on the money – I mean, literally sitting on the pile of cash – and made more than Greenlight made for them.


Citadel investors would have waited longer, until October 16th, 2017, but then could have sold and sat on their money as well, perhaps just hanging out like this kid and playing Dueling Banjos (I think of Ned Beatty as the poor hedge fund investor).

Oh, and they would have paid expenses of 0.04% instead of 2% (or more!) and 20%.

This is no new phenomenon. A nice article on (so much great content there) has this great graph:

Screen Shot 2018-02-22 at 2.02.42 PM

Hedge fund underperformance relative to the S&P500 is amazing, really. I mean, in an efficient market, you’d think it would be really tough to do this badly (but see my article, Why Indexing Works for the explanation).

Oh, and don’t take too much solace from the graph above if you think bad times are coming. In 2008, Citadel – managed by one of the smartest people I’ve ever met – lost nearly 60%.

If you are investing in hedge funds that aren’t performing, you may be the Dumb Money (tip of the hat to Jeff Foxworthy).


No, Passive Investing Didn’t Crash Your Market.

Businessman concept,  Active or Passive road to the correct way.

A popular theme toward the end of last week was to blame passive investment products for the market’s decline. There is no evidence for this, and I have yet to hear anyone credit passive investing for Friday’s and today’s rebound, but passive’s critics place their blame anyway.

This is part of a recent “if you can’t beat ’em, call them dangerous” strategy that active managers are employing. As the evidence becomes more and more overwhelming that active management is a rip-off for most investors (worst of all for most hedge fund investors, most of whom really are the dumbest money in the market for paying 2 and 20 to their hedge fund managers for consistently sub-benchmark performance), active managers have put less effort lately into resisting that evidence and more into accusing passive investors of wrecking the markets. Again, this argument is evidence-free; it never comes with data to back it up.

Instead, there are very good reasons to believe that passive investment, if anything, is making markets calmer, not more volatile. After all, an investor in Vanguard’s S&P500 index faces only the highly-highly diversified return of a market-weighted portfolio of more than 500 securities (because there are some dual-class shares in there). When on Friday, February 2, 2018, the S&P500 closed down, I strongly suspect that 99%+ of Vanguard’s index investors had no idea that L Brands Inc. was down 21.11% for the year, or Chesapeake Energy Corp. was down 15.91%, or Ford down 12.09%. Some may have been watching closely enough to know their index investment was still up a bit over 2% in total for the year, but many probably weren’t paying attention at all. They were working their day jobs or, as in the case my kids’ 529 plans, in grade school studying and talking with their friends.

Those most likely freaking out that day and Monday of last week were the active managers and their algorithms (and I have nothing against algorithms). No one at Vanguard was worried about losing their job because they made a bad investment decision in the S&P500 index fund. But someone at Janus or Citadel or Greenlight or Perry Capital (… oh wait, they are gone now, right?) might well have been.

Nothing looks quite so Zen at a time of market volatility as an index fund. Most S&P500 index investors entered last week knowing (1) that in 2017 they again crushed many hedge funds (including many marquee names) at a tiny fraction of the price; (2) they were highly diversified; (3) they were up for the year 2018; and (4) that essentially no decision of their own – other than to invest in the financial product most endorsed by smart and honest financial advisors and academic financial economists – was on trial. That’s a pretty good place to be.

This isn’t to say that some investors didn’t or won’t sell, or that selling wouldn’t be a perfectly good decision. Valuations are high, interest rates are increasing, etc. etc. And it certainly isn’t to say that sector speculation into all “passive” ETFs is a good idea. That’s not what I’m defending. There’s not much passive about that.

But the bulk of passive investment in the largest U.S. equities is not only the smartest money out there – smart enough not to get fleeced by poorly-performing active managers – but is also pretty calm. Don’t point your fingers at them.

Are You the Dumb Money? Chapter 1: Short Vol Traders


This week witnessed the implosion of the short volatility trade, wiping out or significantly impairing a large number of speculators from day traders to mid-size hedge funds.

I admit upfront that I am a bit gleeful about this one. When the TVIX hit an all time low of 5.50 I bought quite a bit. It was clear (as clear as it can be in a world of uncertainty) that volatility could go a bit lower – it had before – but not too much lower. So this thing had about a 40% downside and a huge upside. Sure enough, it went down into the 4’s, but then the inevitable happened. I sold it all around 13-15.  The easiest trade of my life.

But a caveat: this is not a trader’s blogsite. We are developing analytics aimed at ferreting out the charlatans and the alchemists of active money management and we are strong believers in passive investment management.

Most of what you are going to read here is going to try to convince you that it is futile for you to try to beat the market most of the time. The reason is simply this: there are far too many ways for you to underperform the market. Jan Hendrik Witte and I (and our valued co-author Nick Polson) wrote Why Indexing Works to explain why, and Oliver Renick at Bloomberg Markets (before he went to be a star at TD Ameritrade’s new show) wrote a terrific article on our piece and related work. More on that article later.

But occasionally there are opportunities that are so obvious that we will talk about them here. Long vol in late 2017, early 2018 was one of those.

If you were short vol on February 5, 2018 either (1) to the extent of most of your investable wealth; and/or (2) without being “reinsured” at the insanely low prices available to put purchasers or TVIX, etc. purchasers in the market, then you were the dumb money.

If you invested with a fund – like  Chicago-based LJM Partners Inc. – that literally told you it was doing pretty much nothing but this – then you are the dumb money.

If you kept selling vol after I warned you to buy the TVIX (you know who you are!), then you are the dumb money.

All I can say is, “C’mon Man!