The Financial Mirage: Why Most Active Fund Managers Can’t Beat the Market (as we do) part 2

Following last tuesday’s article…

The High Stakes of Hedge Funds

The stakes get even higher when hedge funds enter the picture. Suppose at age 25, you entrust a hedge fund manager with $100K, who generates an annual return of 8%. Considering a 1.5% management and 20% performance fee, by the time you retire at 65, you would have $764K. Meanwhile, your fund manager, who invested nothing, amasses a staggering $1.24M.

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A study by @dollarsanddata revealed that it takes roughly 17 years on average for the fund to outstrip the investor. And while hedge fund managers rake in substantial profits, investors shoulder the risks and reap minimal benefits.

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This problematic dynamic arises because managers take 70% of the alpha they generate. A typical hedge fund’s returns consist of cash, beta, and smart beta, which are practically free for investors. Alpha, which investors should rightly pay for, gets drastically reduced by high management fees. In essence, managers generate 4% alpha, taking nearly 3% in fees per year, leaving investors to take all the risk and see little benefit.

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This stark reality underpins Warren Buffett’s longstanding recommendation to invest in the S&P 500 over individual stocks. In 2005, he placed a $500k bet claiming that no one could select a set of at least five hedge funds that would match the S&P500 over ten years. The only taker was Ted Seides, and unsurprisingly, Buffett won.

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The empirical evidence suggests that the odds are against active fund managers when it comes to outperforming the market. It is not a game of chance or superior skill, but rather a confluence of market conditions, investor sentiment, and the inherent inefficiency of the stock picking process. Moreover, the fee structure of hedge funds siphons off significant profits that rightfully belong to investors.

In contrast, broad-based index funds like the S&P 500 offer a more equitable and risk-diversified approach to investment. Rather than gambling on the performance of individual stocks, investing in the S&P 500 allows you to ride on the general upward trend of the market.

In conclusion, in the pursuit of superior returns, it’s essential to discern the mirages from the oases. Striving for exceptional performance can often lead to underperformance. Therefore, it seems prudent to heed Buffett’s advice: opt for broad market indices over the allure of stock picking or hedge fund managers.

It’s time to flip the script in favor of the investor. Instead of rewarding traditional managers for minimal alpha with significant fees, we should look for funds that really cares about their investors and give them access to Web3 and DEFI universe where the performance can be real if you are able to manage the risk (the most important part of our job in Belobaba).

By doing so, we can start to rectify the skewed risk-reward balance in the financial industry. After all, shouldn’t we, as financial professionals, aspire to see our clients lounging on their own yachts, instead of simply being invited onboard ours?

This might just be one of the most distinguishing features of Belobaba compared to other funds. We are outperforming the market and providing genuine Alpha to our investors. Maybe one day they will invite us to have a drink into their own yatch 😉

Yours in Crypto and AI