Last week, MarketWatch ran an OpEd on hedge funds that managed to insult nearly every participant in the financial marketplace. Hedge funds were described as “dethroned kings” ruling over an “empire of fools.” Hedge funds are a “cautionary tale” filled with insider trading, poor performance and investor backlash. Why, it is so bad that investors are no longer “dazzled” and hedge funds may be as bad as (gasp!) mutual funds.
I read that article with its virtually Shakespearean array of insults and actually wondered where the author keeps his money. Some folks have wagered it’s either under the bed or in Bitcoin, although I suppose there’s a slight chance it could be in a sock in the freezer. (Friendly note: that’s one of the first places that a thief will check.)
For those of you that are regular readers of my blog, you know that I’ve dealt with a number of the assertions in this article before. Let’s start with performance. There are few places where the phrase “Your Mileage May Vary” is as applicable as it is in the world of hedge funds. While there is no doubt that the average hedge fund return was anemic in comparison to the (insert sarcasm here) infallible S&P 500, an average provides merely that – the arithmetic mean of the top and bottom performers (and everything in between).
Assuming that all hedge funds generated lackluster returns because the average hedge fund did is just, well, silly. You can look at articles such as this CNBC piece or this ZeroHedge article to see hedge funds that didn’t just outperform their industry average, but kicked the pants off of the S&P 500 as well. There were funds that were up 30 percent, 40 percent, 50 percent 60 percent or more, to which I simply say “Thank you, sir, may I please have another?” (And for those of you that are wondering, that's from Animal House, not Fifty Shades of Grey.)
For more information on The Truth About Hedge Fund Performance, check out my video blog from last quarter.
I’m also not going to get too deeply into the fee equation as I’ve touched on that a time or two as well. I think the last time was a mere two weeks ago in a blog post about duct tape.
But I have to say, what really buttered my toast this time around was the assertion that, in addition to being greedy underperformers, hedge funds have the corner on the insider trading market as well. The hedge fund inclination to insider trading came up twice in MarketWatch’s short post.
So before we start to tar hedge funds with that particular brush, let’s look at SEC data on enforcement actions, shall we?
The chart below shows all SEC enforcement actions across type and year. Note that insider trading is a relatively small category of enforcement actions. Year over year, insider trading accounts for an average of less than 8 percent of the actions of the SEC, with an average of about 50 insider trading enforcement actions per year.
Now, even if ALL of the insider trading was committed by hedge funds, it would still represent a very small proportion of the hedge fund world. Take the ever-present 10,000 fund estimate that the industry favors: If all 50 of those annual insider trading schemes occurred in a hedge fund, then 0.05 percent of hedge funds would in fact be knaves and rapscallions.
But we know that insider trading is not solely committed by hedge funds. How do we know? We can again check out www.sec.gov and get a sense of who does commit this crime. Some of my particular favorites? Accounting firm partners, amateur golfers, vitamin company former board member, drug trial doctors, former BP employee, two husbands, Green Mountain Coffee employee, and the list goes on. And it’s true that some of these folks made millions in ill-gotten gains, although one guy got only $35,000 and a jet-ski dock. That dude must LOVE to jet ski.
Look, I’m not saying that some hedge fund managers haven’t done bad things. There certainly are hedge funds represented on the insider-trading list, and just today there was an article on a manager that faked his death to avoid paying back investors. But shenanigans aren’t limited to hedge funds and finance. For example, cell phone companies generate about 38,420 complaints per year, in comparison.