Mutual funds: Lessons from the hedge-fund greats
Entrepreneur Mark Cuban once noted that "the number-one job of the hedge-fund manager is not to make sure that you can retire with a smile on your face, it's for him to retire with a smile on his face."
So you can imagine that everyone who made the Hedge Fund Hall of Fame when it opened in 2008 was all smiles, fabulously wealthy money managers who, in some cases, had become household names.
But the funny thing about the Hedge Fun Hall of Fame - which was not an actual place but an online collection put together by Institutional Investor's Alpha - is that once the smiles faded, so did the idea. After the original 14 members of the Hall, no one else was inducted.
That changes this year, as Institutional Investor's Alpha is picking up the ball with a new list of successful hedgies to fete and celebrate.
But in re-launching the Hedge Fund Hall of Fame, the magazine and web site also took a look back at the original 14 inductees, and as I wandered the online halls looking at the pieces that the publication did on the famous money managers upon induction, I tried to come up with the lessons that these fabulously successful investors lived by that could apply to ordinary investors, and that might leave the regular guy with a smile on his face at the end of an investing lifetime.
Since you're probably never going to roam the proverbial halls of the Hedge Fund Hall of Fame, let me be your tour guide. Here are a few lessons that ordinary investors can take from the hedge-fund greats:
• A few years back, I heard David Swensen, chief investment officer at Yale University, say that ordinary people shouldn't attempt to invest as he does, but his success is based in large part "on the ability to pursue an intellectual strategy and stick with it," and his strategy tends to be indifferent to the market.
While indifference is normally a bad thing, from an investment standpoint it means trying to make money regardless of the direction of the market, and that requires taking steps to run a portfolio that can adjust to market conditions, rather than having a portfolio that you simply hope will manage to bring home the bacon every year, even if it is ill-suited to current conditions.• Market indifference also applied to the late Alfred Winslow Jones - considered by most to be the originator or inventor of the modern hedge fund - but for different reasons.
Jones believed that you did not need a traditional allocation to stocks, bonds and cash, and that you should hang in with the stock market in virtually all conditions, provided that you were properly hedged.
That said, he felt that most money managers were not properly hedged. For ordinary investors, however, the lesson from Jones comes by flipping the message; if overweighting to equities in all conditions is right only with proper hedging - something the average guy really doesn't know how to do - then a diversified portfolio is a must, because the risk of being all-equity, all-the-time eventually is going to hit home without appropriate protection.
• Julian Robertson, by comparison, noted that "The basic ingredient for successful investing" is a "pretty good feel of risk versus reward." What's interesting about that feel, as it pertains to Robertson - now retired from Tiger Management Corp. - is that the more he got the risk-reward balance right, the more his strategy changed to where he took risks where he felt properly compensated for accepting; too many investors fail to consider their return relative to the dangers they face in an effort to earn it.
• Seth Klarman, founder of the Baupost Group, said that the secret to his success was the ability to answer the question "What's your edge?"
"The market's very competitive; there are a lot of smart, talented people, a lot of money-chasing opportunity," Klarman said in 2008. "If you don't have an edge and can't articulate it, you probably aren't going to outperform."
That applies to small investors as well; plenty of people think they are good investors, but their portfolios show that they are better off in index funds than in trying to fight to beat the market. If you can't determine your edge, maybe you don't have one, and should invest like it.• Michael Steinhardt of Steinhardt Partners noted that "today's managers are more interested in relative performance. When I was investing, I measured it only one way - raw performance."
In the modern world of mutual funds, too, money managers and many investors are caught up more in how a fund did relative to its peers than whether it really did well. The top funds in the financial crisis of 2008, for example, still lost a fortune, they just didn't do so badly compared to their peers.
While that's important in choosing an all-weather fund, you can't eat relative performance; if your diversified portfolio includes a lot of "good losers," it may be time to change your focus.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@MarketWatch.com or at Box 70, Cohasset, MA 02025-0070.
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