Something I've observed over the past decade of writing about hedge funds is that they're all very different. While some sections of the financial media seem to like to attack hedge funds for being nothing more than closet indexers with high fees, this is far from the truth.
A large section of the industry does fall into this bracket (and the same is true with actively managed mutual funds and exchange-traded funds), but there's a large number of funds that have not only beaten the market over the long term, but outperformed it significantly.
Distinguishing active funds
The main point any investor has to ask when selecting an active fund --and this is the case with hedge funds, mutual funds and ETFs -- is if they understand the strategy.
Like stocks, funds should not be bought without understanding what makes them work and what the managers' style is. Understanding how the fund works is just as important as understanding how a business works. This applies to investors and fund managers across the spectrum, from large private offices to endowments and retail investors. The funds one owns should fit into one's investment strategy.
This brings me to my main point. There's no right or wrong way to run a hedge fund or active fund. Some funds chose only to own a few holdings in the portfolio and still achieve superior results. Others can own a well-diversified portfolio.
Different funds, different styles
Nomad returned 20.8% per annum return before fees between September 2001 and December 2013. On a net basis, the fund returned 18.4%, compared to an annualized return of 6.5% for the firm's benchmark, the MSCI World. Sleep achieved this performance with more than 90% of Nomad's assets invested in three stocks.
On the other hand, Tiger Global's flagship long-short equity fund has compounded investors' capital at 21% per annum after fees for the past 20 years. At the end of 2020, the portfolio contained 100 different equities on the long side, according to the firm's 13F report.
Norbert Lou's Punch Card Capital portfolio rarely has more than six holdings. Between June 2004 and Sept. 30, 2011, he outperformed the S&P 500 by 12.3% annualized. Meanwhile, TCI Fund Management has returned around 18% per annum net of fees. There are currently 13 holdings in the portfolio.
Through the end of 2017, Kynikos Capital Partners achieved a net annualized gain of 28.6% since its launch in October 1985. How did he do it? According to reports, Chanos has mixed leverage with passive funds and selective shorting.
The point is, there are many ways to run a fund and many ways to earn a high return. Investors should choose a strategy that works for them and that they understand. It does not make any sense to copy a strategy just because it has been shown to outperform.
Another thing to note is that every type of strategy will have winners and losers. Nomad owned three main stocks, which worked for that fund. Even Warren Buffett (Trades, Portfolio) has rarely held a portfolio that concentrated. It worked for Nomad, but has most likely not worked for many other fund managers and individual investors.
The fact is, there is no one-size-fits-all solution to managing a portfolio. Some strategies will work better for some investors than others.
It's all about finding a balance that works. There's no sense following a strategy one feels uncomfortable with because this is likely to lead the mistakes.
Read more here:
- Trying to Place a Value on Berkshire Hathaway
- This Active Investment Fund Has Returned 18.2% Annually
- Nick Sleep: The Best Founders Don't Care About Money
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