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Go Thinking about putting some money into hedge funds? You know, all the rockstar names who produce eye popping returns. Chasing that performance has led the hedge fund space to swell to over five trillion dollars in assets today, with forecasts topping thirteen trillion globally by twenty thirty two. But not all hedge funds are created equally. Investors should ask themselves is this the right investment vehicle for me? I'm Barry Ridolts, and on today's edition of At the Money, we're gonna discuss how you should think about investing your money in hedge funds. To help us unpack all of this and what it means for your portfolio, top bring in Ted Side's Ted began his career under the legendary David Swinson at the Yale University Investments Office. Today he's founder and CIO of Capital Allocators and hosts a podcast by the same name. His book, So You Want to Start a Hedge Fund? Lessons for Managers and Allocators is the seminal work in the space. So Ted, let's start out with the basics why hedge funds. What's the appeal.

Go Thinking about putting some money into hedge funds? You know, all the rockstar names who produce eye popping returns. Chasing that performance has led the hedge fund space to swell to over five trillion dollars in assets today, with forecasts topping thirteen trillion globally by twenty thirty two. But not all hedge funds are created equally. Investors should ask themselves is this the right investment vehicle for me? I'm Barry Ridolts, and on today's edition of At the Money, we're gonna discuss how you should think about investing your money in hedge funds. To help us unpack all of this and what it means for your portfolio, top bring in Ted Side's Ted began his career under the legendary David Swinson at the Yale University Investments Office. Today he's founder and CIO of Capital Allocators and hosts a podcast by the same name. His book, So You Want to Start a Hedge Fund? Lessons for Managers and Allocators is the seminal work in the space. So Ted, let's start out with the basics why hedge funds. What's the appeal.

The original premise of hedge funds was to deliver an equity like return in marketable securities with less risk than the equity markets.

The original premise of hedge funds was to deliver an equity like return in marketable securities with less risk than the equity markets.

So literally, hedged funds.

So literally, hedged funds.

A fund that had some hedging component that would reduce risk.

A fund that had some hedging component that would reduce risk.

And today I think a lot of so called hedge funds are not exactly edged. They seem to be falling into all sorts of different silos.

And today I think a lot of so called hedge funds are not exactly edged. They seem to be falling into all sorts of different silos.

Yeah, so hedge fund as a term became this very ubiquitous label, and if you look at how the industries evolve today, you have funds that fall under hedge funds that look like that original premise of equity like returns, and then you have a whole other set that look more like bond like returns. And different strategies can fit into those two different groupings.

Yeah, so hedge fund as a term became this very ubiquitous label, and if you look at how the industries evolve today, you have funds that fall under hedge funds that look like that original premise of equity like returns, and then you have a whole other set that look more like bond like returns. And different strategies can fit into those two different groupings.

So I mentioned in the introduction, we always seem to hear about the top two percent of fund managers who are the rock stars. Anyone who puts up like really big numbers wildly up before in the market sort of gets fetted by the media and then they sort of fade back into what they were doing. It seems to create unrealistic expectations among a lot of investors. What sort of investment return expectations should people investing in hedge funds have.

So I mentioned in the introduction, we always seem to hear about the top two percent of fund managers who are the rock stars. Anyone who puts up like really big numbers wildly up before in the market sort of gets fetted by the media and then they sort of fade back into what they were doing. It seems to create unrealistic expectations among a lot of investors. What sort of investment return expectations should people investing in hedge funds have.

Yeah, those expectations should be more modest than what you might read in the press. Barry. What you just described describes markets. People do well, they revert to the mean. It happens in every strategy, and certainly the news sensationalizes great performance and lousy performance. So what you might read in the press is these incredible renaissance medallion fifty percent a year with these high.

Yeah, those expectations should be more modest than what you might read in the press. Barry. What you just described describes markets. People do well, they revert to the mean. It happens in every strategy, and certainly the news sensationalizes great performance and lousy performance. So what you might read in the press is these incredible renaissance medallion fifty percent a year with these high.

Fees sixty eight percent. If I recall Zuckerman's book, Greg Zuckerman's book on Jim Simon.

Fees sixty eight percent. If I recall Zuckerman's book, Greg Zuckerman's book on Jim Simon.

Now, if you looked at hedge funds as a whole and try to get at let's say that equity like expected return you're talking about like a high single digits number, has nothing to do with sixty eight percent. Most of the action isn't on either tail. Most of the actions right in the middle.

Now, if you looked at hedge funds as a whole and try to get at let's say that equity like expected return you're talking about like a high single digits number, has nothing to do with sixty eight percent. Most of the action isn't on either tail. Most of the actions right in the middle.

That seems to be very contrary to how we read and hear about hedge funds in the media. Is it that whoever's hot at the moment captures, you know, the public's fancy and then on to the next That's not how the professionals really think about the space, is it.

That seems to be very contrary to how we read and hear about hedge funds in the media. Is it that whoever's hot at the moment captures, you know, the public's fancy and then on to the next That's not how the professionals really think about the space, is it.

No, that's right. I think that's generally how the media works it investing. The news stories are the things that are on the tails. But it's not how hedge funds are invested in by those who have their money at risk. They're really looking at it as risk mitigating strategies relative to your say, traditional stock and bond alternatives.

No, that's right. I think that's generally how the media works it investing. The news stories are the things that are on the tails. But it's not how hedge funds are invested in by those who have their money at risk. They're really looking at it as risk mitigating strategies relative to your say, traditional stock and bond alternatives.

So we talk about alpha, which is outperformance over what the market gives you, which is beta. Lately, it seems that alpha comes from two places, emerging managers, new fund managers who kind of identify market inefficiency, and the quants who have seemed to be doing really well as of late. What do you think about these two sub sectors within the hedge fund space.

So we talk about alpha, which is outperformance over what the market gives you, which is beta. Lately, it seems that alpha comes from two places, emerging managers, new fund managers who kind of identify market inefficiency, and the quants who have seemed to be doing really well as of late. What do you think about these two sub sectors within the hedge fund space.

Well, in all the asset management, there's this aphorism size is the enemy of performance, and it's certainly been true in hedge funds that generally speaking, for a long time, smaller funds have done better than larger funds. Not so sure that's the case of emerging funds, which means new but on size you get that. Now, what's an interesting dynamic, and it gets into the quant is more and more money has been sucked in by these so called platform hedge funds. So Citadel Millennium point seventy two, places like that, where have they have multiple portfolio managers and do a phenomenal job at risk control, and they've seemingly in good markets and bad generated that nice equity like expected return, and there has to be alpha in that because there's not a lot of beta.

Well, in all the asset management, there's this aphorism size is the enemy of performance, and it's certainly been true in hedge funds that generally speaking, for a long time, smaller funds have done better than larger funds. Not so sure that's the case of emerging funds, which means new but on size you get that. Now, what's an interesting dynamic, and it gets into the quant is more and more money has been sucked in by these so called platform hedge funds. So Citadel Millennium point seventy two, places like that, where have they have multiple portfolio managers and do a phenomenal job at risk control, and they've seemingly in good markets and bad generated that nice equity like expected return, and there has to be alpha in that because there's not a lot of beta.

That's really kind of interesting. You said something in your book that resonated with me. The best allocators establish clear processes for evaluating opportunities and setting priorities. Explain what you mean by that.

That's really kind of interesting. You said something in your book that resonated with me. The best allocators establish clear processes for evaluating opportunities and setting priorities. Explain what you mean by that.

Well, before you just decide I want to invest in a hedge fund, it's really important to understand how are you thinking about your portfolio and how do hedge funds fit in. Now, keep in mind hedge funds can mean lots of different things, and that the strategies pursued by one hedge funds is going to look totally different from another one. So you need to understand what is it you're trying to accomplish. Are you trying to beat the markets with your hedge fund allocation? Okay, you better go to one that takes a lot of aggressive risk. Are you trying to mitigate equity risk but get equity like returns. Okay, you might want to look at a Jones model hedge fund that has lungs and shorts but has market risk, or are you trying to beat the bond markets? You better go to one that doesn't take equity risk. So you need to understand in advance what is it you're trying to accomplish through that investment, and then go look for the solution, not the other way around, just by saying, oh, hedge funds are a good thing, let me go invest in them.

Well, before you just decide I want to invest in a hedge fund, it's really important to understand how are you thinking about your portfolio and how do hedge funds fit in. Now, keep in mind hedge funds can mean lots of different things, and that the strategies pursued by one hedge funds is going to look totally different from another one. So you need to understand what is it you're trying to accomplish. Are you trying to beat the markets with your hedge fund allocation? Okay, you better go to one that takes a lot of aggressive risk. Are you trying to mitigate equity risk but get equity like returns. Okay, you might want to look at a Jones model hedge fund that has lungs and shorts but has market risk, or are you trying to beat the bond markets? You better go to one that doesn't take equity risk. So you need to understand in advance what is it you're trying to accomplish through that investment, and then go look for the solution, not the other way around, just by saying, oh, hedge funds are a good thing, let me go invest in them.

So that sounds a lot like another phrase I read in the book, and acute awareness of risk? Should investors be thinking about performance first? Should they be thinking about risk first? Or are these two sides of this coin?

So that sounds a lot like another phrase I read in the book, and acute awareness of risk? Should investors be thinking about performance first? Should they be thinking about risk first? Or are these two sides of this coin?

There are two sides of the same coin, but without a doubt, investors should be thinking about risk first. And that's not specific to hedge funds. I would argue that's true in all of investing. If you understand the risk you're taking and you look for some type of asymmetry or convexity, the rewards can take care of themselves. But where you really get tripped up in hedge funds and there's a long history of this, going back to long term capital in nineteen ninety eight is when risk gets out of control.

There are two sides of the same coin, but without a doubt, investors should be thinking about risk first. And that's not specific to hedge funds. I would argue that's true in all of investing. If you understand the risk you're taking and you look for some type of asymmetry or convexity, the rewards can take care of themselves. But where you really get tripped up in hedge funds and there's a long history of this, going back to long term capital in nineteen ninety eight is when risk gets out of control.

And long term capital management very famously blew up when Russia defaulted on their bonds. They were leveraged one hundred to one, so this wasn't like a bad year, this was pretty much a wipeout. How can an investor evaluate those risks in advance.

And long term capital management very famously blew up when Russia defaulted on their bonds. They were leveraged one hundred to one, so this wasn't like a bad year, this was pretty much a wipeout. How can an investor evaluate those risks in advance.

Well, there are three pillars that don't go together. Well, concentration, leverage, and illiquidity. Take any one of those risks, but if you take two or certainly three at the same time, that's a recipe for disaster.

Well, there are three pillars that don't go together. Well, concentration, leverage, and illiquidity. Take any one of those risks, but if you take two or certainly three at the same time, that's a recipe for disaster.

So your podcast is called Capital Allocators. Leads to the obvious question, what percentage of capital should investors be thinking about allocating to hedge funds? Whether they're a large institution or just a high net worth family office. Where do we go in terms of what's a reasonable amount of risk to take relative to the capital appreciation you're seeking.

So your podcast is called Capital Allocators. Leads to the obvious question, what percentage of capital should investors be thinking about allocating to hedge funds? Whether they're a large institution or just a high net worth family office. Where do we go in terms of what's a reasonable amount of risk to take relative to the capital appreciation you're seeking.

Well, if you start with a traditional risk construct, so let's say that's a seventy thirty stock bond or sixty forty, say seventy thirty, the question becomes outside of your stocks and bonds, where can you get diversification, And you might want to say, okay, I want equity like hedge funds. And if you look at some of the most sophisticated institutions, that might be as much as twenty percent of their portfolio. The biggest difference for those institutions and the high net worth individuals are taxes. Most hedge fund strategies are tax inefficient. So that of that five trillion dollars, the vast majority of it, maybe even as much as ninety percent, are non taxable investors. There are only some hedge fund strategies, and they tend to be things like activism that have longer duration investment holding periods that make sense for taxable investors.

Well, if you start with a traditional risk construct, so let's say that's a seventy thirty stock bond or sixty forty, say seventy thirty, the question becomes outside of your stocks and bonds, where can you get diversification, And you might want to say, okay, I want equity like hedge funds. And if you look at some of the most sophisticated institutions, that might be as much as twenty percent of their portfolio. The biggest difference for those institutions and the high net worth individuals are taxes. Most hedge fund strategies are tax inefficient. So that of that five trillion dollars, the vast majority of it, maybe even as much as ninety percent, are non taxable investors. There are only some hedge fund strategies, and they tend to be things like activism that have longer duration investment holding periods that make sense for taxable investors.

So and when you say non taxable investors, I'm thinking of foundations, endowments large, not even tax deferred, just tax exempt entities that can put that money to work without worrying about Uncle Sam.

So and when you say non taxable investors, I'm thinking of foundations, endowments large, not even tax deferred, just tax exempt entities that can put that money to work without worrying about Uncle Sam.

That is, that's right, YEA pension funds non US investors as well.

That is, that's right, YEA pension funds non US investors as well.

All right, So if you're not you know, the l endowment, but you're running a pool of money, how much do you need to have to think about hedge funds as an alternative for your portfolio.

All right, So if you're not you know, the l endowment, but you're running a pool of money, how much do you need to have to think about hedge funds as an alternative for your portfolio.

You're probably in the double digit millions before millions and nothing about it.

You're probably in the double digit millions before millions and nothing about it.

Yeah, ten million and up, and you could start thinking about it and then what's a rational percentage? Is this a ten percent shift or is this something more or less?

Yeah, ten million and up, and you could start thinking about it and then what's a rational percentage? Is this a ten percent shift or is this something more or less?

I know, for me individually, it's a lot less than it was when I was managing capital for institutions. So for me individually, it's about five percent because I need to feel like the managers are so good that they can make up for that tax disadvantage.

I know, for me individually, it's a lot less than it was when I was managing capital for institutions. So for me individually, it's about five percent because I need to feel like the managers are so good that they can make up for that tax disadvantage.

And so taxes are part of it. Ill equidally is part of it, and risk is part of it. Are those Is that the unholy trifecta that keep you at five percent?

And so taxes are part of it. Ill equidally is part of it, and risk is part of it. Are those Is that the unholy trifecta that keep you at five percent?

Yeah, depending on the strategy. A lot of hedgehund strategies have quarterly liquidity, so it's not daily, but they are relatively liquid. But for sure taxes matter, and then it's just risk. How much risk are you willing to take in the markets?

Yeah, depending on the strategy. A lot of hedgehund strategies have quarterly liquidity, so it's not daily, but they are relatively liquid. But for sure taxes matter, and then it's just risk. How much risk are you willing to take in the markets?

And you know, since you mentioned liquidally, we hear about gates going up every now and then. Where a hedge funnel say, hey, we're we're you know a little this quarter and we're not letting any money out. How do you deal with that, as an investor, you have to be.

And you know, since you mentioned liquidally, we hear about gates going up every now and then. Where a hedge funnel say, hey, we're we're you know a little this quarter and we're not letting any money out. How do you deal with that, as an investor, you have to be.

Very careful about what the structure of your investment is. So to take an example, in the world of credit, distressed debt used to be bucketed in hedge fund strategies with quarterly liquidity, but it's not a great match for the underlying liquidity of those debt instruments. More and more those moved into medium terms, a two to five year investment vehicles, and now you see much more of that in the private credit world that have an asset liability match. It's much more appropriate for the underlying assets. So it's less what the liquidity is and trying to make sure that whatever that hedge fund manager is investing in is appropriate for the liquidity that they're offering.

Very careful about what the structure of your investment is. So to take an example, in the world of credit, distressed debt used to be bucketed in hedge fund strategies with quarterly liquidity, but it's not a great match for the underlying liquidity of those debt instruments. More and more those moved into medium terms, a two to five year investment vehicles, and now you see much more of that in the private credit world that have an asset liability match. It's much more appropriate for the underlying assets. So it's less what the liquidity is and trying to make sure that whatever that hedge fund manager is investing in is appropriate for the liquidity that they're offering.

So let's talk a little bit about performance. Before the Financial Crisis, it seemed that every hedge fund was just killing it and printing money. Following the Great Financial Crisis, hedge funds have struggled. Some people have said, you only want to be in the top decile or two. What are your thoughts on who's generating alpha and how far down the line you could go before you know you're in the bottom half of the performance track.

So let's talk a little bit about performance. Before the Financial Crisis, it seemed that every hedge fund was just killing it and printing money. Following the Great Financial Crisis, hedge funds have struggled. Some people have said, you only want to be in the top decile or two. What are your thoughts on who's generating alpha and how far down the line you could go before you know you're in the bottom half of the performance track.

Yeah, I mean over these last fifteen years, the world has gotten a lot more competitive. So for sure, whatever pool of alpha is available before the financial crisis, if it's the same pool, it's there are a lot more dollars pursuing it, and it's been much harder to extract those returns. So I do think it's become the case that some of the more proven managers that have demonstrated they can generate excess returns are the ones who have commanded more dollars. And so you've seen an increased concentration of the assets going to certain managers in the hedge fund space.

Yeah, I mean over these last fifteen years, the world has gotten a lot more competitive. So for sure, whatever pool of alpha is available before the financial crisis, if it's the same pool, it's there are a lot more dollars pursuing it, and it's been much harder to extract those returns. So I do think it's become the case that some of the more proven managers that have demonstrated they can generate excess returns are the ones who have commanded more dollars. And so you've seen an increased concentration of the assets going to certain managers in the hedge fund space.

Let's talk about fees. Two and twenty has been the famous number for hedge funds for a long time. Although we have heard over the past ten years about one in ten, one in fifteen, where are we in the world of fees.

Let's talk about fees. Two and twenty has been the famous number for hedge funds for a long time. Although we have heard over the past ten years about one in ten, one in fifteen, where are we in the world of fees.

You don't see a lot of two and twenty. And part of that is that fees are just determined by supply and demand. Think of it as a clearing price for supply and demand. So when returns generally have come down, those strategies don't really command as high a fee structure because the gross return is lower. The pies a little smaller. You need to take a smaller slice of that pie. The exceptions to that, of course, are the managers who have continued to deliver, and in some instances you actually see fees going.

You don't see a lot of two and twenty. And part of that is that fees are just determined by supply and demand. Think of it as a clearing price for supply and demand. So when returns generally have come down, those strategies don't really command as high a fee structure because the gross return is lower. The pies a little smaller. You need to take a smaller slice of that pie. The exceptions to that, of course, are the managers who have continued to deliver, and in some instances you actually see fees going.

Up three and thirty.

Up three and thirty.

You've seen a deep Shaw raise their fees a year or two go. But for the most part, that kind of one and a half and fifteen is probably around where the industry is.

You've seen a deep Shaw raise their fees a year or two go. But for the most part, that kind of one and a half and fifteen is probably around where the industry is.

And there was a movement a couple of years ago towards pivot fees or beta plus, which was, hey, we're going to charge you a very modest fee and you're going to pay us only on our outperformance over the market. What happened with that movement? Did that gain any traction or where are we with that?

And there was a movement a couple of years ago towards pivot fees or beta plus, which was, hey, we're going to charge you a very modest fee and you're going to pay us only on our outperformance over the market. What happened with that movement? Did that gain any traction or where are we with that?

Most of the institutions would be happy to pay high fees for true alpha, so there are always efforts to try to figure out how do you separate the alpha from the beta? How can we pay not much for the beta and happy to pay a lot for the alpha. At the same time, of the five trillion in assets, two or three trillion have existed before people started talking about that, so you already had a handshake on what the deal is those handshakes often are difficult to change, but for sure in new structures, when new capital gets allocated, you do see that attempt to really isolate paying for performance.

Most of the institutions would be happy to pay high fees for true alpha, so there are always efforts to try to figure out how do you separate the alpha from the beta? How can we pay not much for the beta and happy to pay a lot for the alpha. At the same time, of the five trillion in assets, two or three trillion have existed before people started talking about that, so you already had a handshake on what the deal is those handshakes often are difficult to change, but for sure in new structures, when new capital gets allocated, you do see that attempt to really isolate paying for performance.

So to sum up, if you have a long term perspective and you're not awed by some of the big names and rock stars who occasionally put up spectacular numbers, and you're sitting on enough capital that you can allocate five percent or ten percent to a fund that might be a little risk and have a little higher tax effects, but simultaneously could diversify your returns and could generate better than expected returns. You might want to think about this space. You really want to think closely about your strategy and your liquidity requirements, and be aware of the fact that the best funds may not be open to you, and you may not have enough capital to put money in that. But if you're sitting on enough cash, and if you have identified a fund that's a good fit with your strategy and your risk tolerance, there are some advantages to hedge fund investing that you don't get from traditional sixty forty portfolios. I'm Barry Ridults. You're listening to Bloombergs at the Money Enough I want to take a body chet MHM,

So to sum up, if you have a long term perspective and you're not awed by some of the big names and rock stars who occasionally put up spectacular numbers, and you're sitting on enough capital that you can allocate five percent or ten percent to a fund that might be a little risk and have a little higher tax effects, but simultaneously could diversify your returns and could generate better than expected returns. You might want to think about this space. You really want to think closely about your strategy and your liquidity requirements, and be aware of the fact that the best funds may not be open to you, and you may not have enough capital to put money in that. But if you're sitting on enough cash, and if you have identified a fund that's a good fit with your strategy and your risk tolerance, there are some advantages to hedge fund investing that you don't get from traditional sixty forty portfolios. I'm Barry Ridults. You're listening to Bloombergs at the Money Enough I want to take a body chet MHM,