Where Does All That Hedge Fund Alpha Go?
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The vast majority ends up in managers’ pockets. No wonder they have so many yachts.
For years investors in hedge funds have experienced a difficult combination of high fees, low returns, and high correlation to other assets in their portfolios. Put together that makes hedge funds look like a bad deal.
This result is not because the alpha generated by the managers’ strategies are poorly performing. Exactly the opposite is true. Excluding fees, the returns from the hedge fund industry as a whole over the last 20 years have been as good as stock returns with about 40% the risk. That's a great return stream.
The problem is that the managers are taking 70% of the alpha they generate. The chart below shows the return composition of the hedge fund industry. Half of the return comes from cash, beta, and smart beta which are all close to free for investors. Alpha is what investors should pay for since they can't get it elsewhere.
Managers have generated 4% alpha, but taken nearly 3% in fees per year, leaving investors to take all the risk and see little benefit. At Unlimited we aim to flip this split with the products we offer to investors and with it hopefully one day we’ll be invited on one of our customers' yachts.