TBP Conf 2013
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Transcript of TBP Conf 2013
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The High Cost of Chasing Performance
Presentation by Barry Ritholtz
The Big Picture Conference, October 8, 2013
McGraw-Hill Auditorium, NYC
Romancing Alpha,Forsaking Beta
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1. Herding, Groupthink
2. Experts: Articulate Incompetents
3. Optimism Bias
4. Confirmation Bias
5. Recency Effect
6. Emotions impact perception
7. Anticipation vs. Rewards
8. Selective Perception & Retention
9. A Species of Dopamine Addicts
10. Endowment Effect of Ownership
11. Monkeys Love a Narrative
12. Cognitive Errors Impact Processes
Behavioral Economics Neuro-Finance
How Does Your Brain Interfere With Your Investing?
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Thisis
your
brainon
stocks
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Looking at Alternative Investments
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1. Hedge Funds manage ~1% of total financial assets
(Yet capture an disproportionate amount of media mindshare).
2. Hedge fund 2&20% fees exert enormous drag on returns;
3. Total Asset Weighted Alpha generated by tiny % of managers
(Non Gaussian Dispersion = Fat head/Long tail)
4. Many funds start out creating Alpha but morph into fee capture
5. Picking new & emerging managers is exceedingly difficult;
(Your biases make the process even harder)
Some Surprising Hedge Fund Info
What Dont You Know About Hedge Fund Investing
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Global hedge fund industry = $2.13T
Given what a relatively small asset
class this is, they receive an excess ofmedia attention.
Perhaps because so many hedge fund
managers have become billionaires,
they have captured the investing
publics imaginations
Hedge Funds = 1.1% All Financial Assets
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How Have Hedge Funds Done?
2012 = Returns equaled 3.5% versus S&P 500-stock index 16%
2007-12 = Lost 13.6% vs. S&P 500-stock +8.6%
2013 = Gained 4.52% YTD vs. S&P 500-stock +14.5% YTD
Source: WSJ, HFRX
HFRX Global Hedge Fund Index Performance Data
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Diminishing Hedge Fund Returns
Alpha has diminishing returns to scale because many strategies only apply to smaller stocks and/or prices
move against managers if they try to execute trades that are too large. Source: WSJ
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1997 = $118 billion
2012 = $2.04 trillion.
Hedge Fund Growth
1. Talent Dilution2. Excess Size3. Correlation / Indexers
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The Daunting Math of Mutual Fund Manager Selection
1.Only 20% of active managers (1 in 5) can outperform their benchmarks inany given year;
2.Within that quintile, less than half (1 in 10) outperform in two out of thenext three years;
3.Only 3% stayed in the top 20% over five years (1 in 33)4.Once we include costs and fees, less than 1% (1 in 100) manage tooutperform (net).
5.What are the odds you can pick that 1 in 100 manager?
Optimism Bias at Work
Sources: Morningstar, Vanguard
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56% said they invested in hedge funds for diversification purposes
Hedge funds correlated with other vehicles, falling in crisis
Is Your Original Investing theme valid? 81% of investors said Yes (as of 2009)
Confirmation Bias in Action
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Managers Capture Investment ProfitsMostly For Themselves
From 1998-2010 hedge fund managers earned $379 billion in fees. The
investors in their funds earned only $70 billion in investing gains.
Managers kept 84% of investment profits, investors netted 16%.
As many as 1/3 of hedge funds use feeder and/or fund of funds. This brings
the industry fee total to $440 billion thats 98% of capture.
Investors are left with $9 billion dollars merely 2%.
Source: Simon Lack, The Hedge Fund Mirage
Is This Rational Investing?
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Who Profits from Hedge Funds?
Source: Hedge Fund Mirage.via Falkenblog
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Hedge Fund Manager Profit Capture
Does not include Survivorship Bias, self reporting. Assume +3%
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Who Profits from Hedge Funds?
Source: Hedge Fund Mirage.via Falkenblog
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2 smart guys leave Goldman Sachs to set up a hedge fund; They raise
$1 billion dollars:
Performance:
Year 1: +15% (Total S&P500+Div=17%)
Year 2: +10% (S&P500 = 14%)
Year 3: -5% , (return capital) (S&P500 = 12%)
Earnings (2 + 20%):
Year 1: $20m + $30m
Year 2: $22m + $22m
Year 3: $24m + $0
Total Comp = $118m
Two Smart Guys
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Comparable Compensation
Source: Forbes
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Top Hedge Fund Manager Compensation (Hourly)
Source: Forbes
It takes the
average family
18.5 years to
make whatthese hedge
fund managers
make in 1 hour
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1. Herding, Groupthink
2. Experts: Articulate Incompetents
3. Optimism Bias
4. Confirmation Bias
5. Recency Effect
6. Emotions impact perception
7. Anticipation vs. Rewards
8. Selective Perception & Retention
9. A Species of Dopamine Addicts
10. Endowment Effect of Ownership
11. Monkeys Love a Narrative
12. Cognitive Errors Impact Processes
Behavioral Economics Neuro-Finance
How Does Your Brain Interfere With Your Investing?
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Understand What You Can and Cannot Do Well As Managers
-How overweight in alt (PE/HF/VC) investments are you?
-Focus on Asset Allocation (15 distinct classes)-Use Core & Satellite Approach to Reduce Temptations
-Take Advantage of Mean Reversion via class rebalancing-Lower your expectations until the next 1982 comes along
-Think longer term
-Get Unsexy!
What Should Investors Do ?
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We have met the
enemy, and he is us.
-Walt Kelly, Pogo, 1971
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Supplemental
Materials
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Manager Selection isMuch Harder Than People Believe
-John Paulson launched his hedge fund in 1994
-Hires Paulo Pellgrini in 2004-Raised $147 million in 2006 for Subprime Bet
-Greatest Trade Ever in 2006-07-Assets under management had swelled to $36 billion.
-Subsequent losses were 52% in one fund, 35% in another.
Paulson Hedge Fund
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Manager Selection isMuch Harder Than People Believe
Paulson gave Pellegrini a $175 million bonus . . .
Response: F#$% you, I quit
Formed PSQR in 2008
Returns:
2008 = 40%
2009 = 61.6%
2010 = -11%
August 2010, Pellegrini returned all outside investor capital
Pellegrini PSQR Hedge Fund
Sources: Greg Zuckerman, The Greatest Trade, WSJ
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Hedge Fund Attrition WhenafundleavestheLipperTASSdatabaseorstopsrepor7ng,thedatabaselistsone
ofthefollowingasthepossiblereason: Fundclosedtonewinvestment. Funddormant. Fundhasmergedintoanotheren7ty. Fundliquidated. Fundnolongerrepor7ng. Programclosed. Unabletocontactfund. Unknown.
92%offundsthatleavethedatabaseareassignedtojustthreeofthe8reasons:fundliquidated(36%),fundnolongerrepor7ng(38%),andunabletocontactfund(18%)
Ifafundleavesthedatabasebecauseitliquidated,itissafetoassumethatthedecisionwasbasedlargelyonpoorperformance
Theari7onforfundsthatreportedreturnsforthemonthofDecember2006(whichcoversthe24monthsthrough2008)isalarminglyhigh-29%to63%ofthefundsseemtohavedisappeared
Basedontheseari7onrates,onecanexpectanywherefrom20%to60%ofthefundsrepor7ngatanygiven7menottolastthroughthenext24months
Suchhighari7onratescanhaveseriousconsequencesforlong-terminvestors Vanguardalsoreportstheaverageannualizedexcessreturnsofthefundsthat
disappear.Theexcessreturniscalculatedwithrespecttothepeersinthehedgefundcategories
Source:hps://www.vanguardinvestments.se/content/documents/Ar7cles/Insights/alt-vs-indexing.pdf
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Underperformance:
Themajorityoffundssixty-twooutof100failedtoexceedreturnsavailablefromthepublicmarkets,a\erfeesandcarrywerepaid.
ThereisnotconsistentevidenceofaJ-curveinventureinves7ngsince199;thetypicalKauffmanFounda7onventurefundreportedpeakinternalrateofreturn(IRRs)andinvestmentmul7ples
earlyinthefundslife. Thecumula7veeffectoffees,carry,andtheunevennatureofventureinves7ngul7matelyle\us
withsixty-ninefunds(8percent)thatdidnotachievereturnssufficienttorewardusforpa7ent,expensive,long-terminves7ng. (hp://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf)
AreportbytheNa7onalVentureCapitalAssocia7on(NVCA)statesthat,Itisinteres7ngtonotethat2012isthefirstpost-bubbleyearinwhichventurefundscollec7velydistributedmorecashtolimitedpartnersthantheybroughtin.(hp://www.prweb.com/releases/2013/5/prweb1000.htm)
(http://smullaney.com/wp-content/uploads/2010/12/VC-Performance1.jpg)
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Outperformance:
Bain & Co. in their 2013 GlobalPrivate Equity Report claim that,despite falling returns (above)and increased volatility (top
right), buyout funds still
outperformed the S&P 500(right).
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Source: Ritholtz.com
Emotions & the Sentiment Cycle
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Barry L. Ritholtz
Ritholtz Wealth Management90 Park Avenue, 18th Floor
New York, NY 10016
212-455-9122
for more information, please contact