Summary: This page looks at who the most successful hedge fund managers are and which are the best hedge funds. It will be very little surprise to hear that the two lists have some correlation!
Before writing anything else, it must be pointed out that the
best hedge fund is a subjective assessment. In a results driven
industry, the 'best' will change regularly, either day by day or month
by month. Additionally,what is the 'best' will be different for each investor. After all, if you really want to invest in the top hedge fund in an area - let's say foreign exchange - that will likely not be the 'best' overall.
This page is not offering guidance as to which hedge funds an individual ought to invest in. It also does not propose to list or name everyone or every fund.
There are a number of funds and managers that stand out from the crowd. They have been able to build a reputation over the years of success and very high profits.
First among equals has to be George Soros. Soros was famous for his currency bets and hedge fund before anyone even knew what one was. He has been one of the leading financial speculators for several decades and could arguably be one of the leading financiers in history. Even having 'retired' to give his money away, he still is able to outperform most other managers every year. To this author at least, he is little short of a marvel.
Next on my list is Steve Cohen of SAC Capital. Cohen has a track record which is just about unequalled. For about twenty years he and his fund has grown at rates above 30% per year. Amazing.
Now long retired, but a legend in the hedge fund world, is Julian Robertson. His Tiger Fund was one of the real trailblazers in the hedge fund world and the traders he trained are now in many other funds around the world.
The last of the individuals to be mentioned is Carl Icahn. Icahn could be described as a private equity manager, corporate raider, shareholder activist or hedge fund manager. As such, he does not really fit the natural profile of any of them. He is, however, a one-man deal machine that seems to be able to keep going and pursue his prey no matter what. He is both highly respected and feared on Wall Street.
Since about 1995 or so, there has been massive growth in funds based on mathematics rather than 'feel' or 'instinct'. These funds are run by mathletes - known as quants - and use highly secretive methods to look for predictable trading opportunities in price movements that mostly are random. Confused? So are the rest of us.
The quants build mathematical algorithms to exploit the tiny advantages they find, and then set those algorithms (combined with immense computing power) out into the markets to look for opportunities.
The most easily understandable (a true oxymoron!) method used is called statistical arbitrage.
In the world of algorithmic trading, there are some true financial heavyweights. These are the funds - and the individuals that own and run them - that are responsible for moving tens of billions of dollars around the world every hour as their computers gobble up the small opportunities they find.
Once set up, these trading machines become money machines. Successful algorithmic funds churn out profits at an amazing rate, which is why so little is known about them (they don't like talking about how they do it for obvious reasons).
Of course, there are several thousand hedge funds around the world and this page only mentions a handful of the most famous. This wide range means that there is almost certainly a fund that specialises in whatever market an investor may hope to invest in.
There are, however, very real risks with investing in hedge funds and this probably ought to be the last investment a private investor makes - after bonds, money markets, his or her own business, mutual funds, pension provision, property, art, gold coins, stocks and shares, and a boat ;-)
These risks have been very ably demonstrated during the financial and sub-prime crisis of 2008. There were a number of very public and high profile hedge fund 'blow ups'. In fact, there are two funds whose demise played a very major part in the end of the investment bank Bear Stearns. The combination of high risks, volatility and write downs in asset prices with exceptionally high levels of borrowing proved to be a very risky proposition. While it has not happened, it has to be presumed that even the best hedge funds can blow up (as was proved by LTCM in 1998).
However, the events surrounding the 2008 financial crisis and the aftermath have showed just how risky some of these funds can be and how close their business models "sail close to the wind" of legality. Without doubt, the vast majority of funds operate legally without issue. Yet the convictions relating to Galleon for insider trading and the complaints made relating to real estate funds that seemed to be set up to fail for a select few fund managers.
The problem for private - and institutional - investors is that because so much of the decision making is proprietary and goes on in secrecy and behind strong non-disclosure agreements, is that it is very hard to tell the difference between the good and the bad. Annual returns are no way to judge this as the Madoff affair has proved.
A problem that is highlighted by the sector is the problems caused by size. It turns out that the more money there is under management, the harder it becomes to generate good returns. There are simply not enough big investment opportunities available that have the potential to "move the needle" for a manager with tens or hundreds of billions under management.
Therefore, most successful funds are closed to new investors. For example, one of the most successful asset allocators ever is Ray Dalio. However, he has been closed to new investors for years! Not only that, when it was last open, a new investor had to be able to prove a net worth of US$5 billion, which obviously limits most readers.
If we put ourselves into Mr Dalio's shoes, who would you want as an investor? One person that can invest multiple hundreds of millions and that you get to know personally and will not need to withdraw any money for years, or (tens of) thousands of private investors putting in a few thousand each with lots of withdrawals and paperwork and customer service requirements? Put like that, it is obvious that most of us cannot access the best hedge funds.
Another problem faced by investors is that these funds use lock in periods that typically last two years or more. The managers do this because of the high levels of borrowing, if too many people were to withdraw their money at the same time, it can cause liquidity problems and in extreme cases cause the fund to close. However, from the perspective of an investor, these lock ins and the high fees make it almost impossible to easily switch to the best performing hedge funds if their manager is on a poor run.
While there are very good reasons why this is the case (from the perspective of the manager) it is another argument used by critics as to why hedge funds are not very suitable investment vehicles for most people.
Not the best
One area that comes in for some criticism is that of hedge fund of funds. These are funds into which investors money is split between a small number of actual funds (information here). Legendary investor Warren Buffett often complains about these funds because of their double layer of fees. These fees increase the 'drag' and make good performance less likely.
The argument for these investments is that the selecting manager helps to find the best performing hedge funds and that by using more than one underlying investment, risk is diversified. There may be some merit in this argument, but many people on Wall Street and Main Street are not convinced.
If you would like to read more about hedge funds, please follow these links:How Do You Define A Hedge Fund?