Hedge funds face the scrutiny of the market

Through their history, hedge funds have been attacked as the worst form of speculative capitalism, to no avail. They have been growing almost non-stop, although their size in the global economy is rather small compared to the amount of press coverage that they receive. Now, however, when they are at the climax of success, they face a new threat: they are being accused of being inefficient.

So far, most of the criticism has come from pundits and commentators. In 2012, former JP Morgan manager Simon Lack published  The Hedge Fund Miracle, a devastating analysis of the so-called ‘hedgies’. One year later, Bloomberg Business Week mocked them in a cover and a piece titled ‘Hedge funds are for suckers’. Last May, Barry Ritholtz, in his Sunday column in The Washington Post, wrote that the success of the hedge fund concept is “the lure of the superstar manager—the guy who can make you fabulously wealthy.”

Now, however, hedge funds are starting to be questioned by some market participants. One week ago, the California Public Employees Retirement System (CalPERS) announced it was terminating its $4.5 bn hedge fund portfolio in order to “reduce complexity and costs.”

‘Complexity and costs’ are the two most commonly levied attacks at hedge funds. These vehicles usually charge fees that are 2% of the original investment plus 20% of profits. That ‘two and twenty’ rule has made that, according to Lack, hedge fund managers had swallowed 84% of the profits from 1998, leaving a meager 16% to investors. Mutual funds, by comparison, only take on average 1.44% of the investment as a fee.

If this is the case, CalPERS’ attitude is comprehensible. But it is equally true that the gigantic pension fund has strict internal rules that forbid it from investing in risky hedge funds, which probably also limited its returns.

But, whatever the case, there is something unquestionable: the 25 richest hedge funds managers got, on average, one billion dollars as compensation in 2013. Unless those 25 funds delivered really impressive results—and many did not—those numbers are too much. Maybe Simmons, Dalio and Paulson and their colleagues will have to get ready for something that can be much tougher than criticism: the scrutiny of the market.