Are Hedge Funds A Con?

There’s this guy named Ray Dalio. He’s a multi-billionaire. And he makes his money running hedge fund company, Bridgewater Associates. Bridgewater is the biggest boy on the hedge fund block, managing $160 billion (USD) on behalf of investors. In 2016, when the S&P 500 clocked a total return of 12.25%, Bridgewater’s largest fund, Pure Alpha, returned a measly 2.4%. Dalio’s reward for huge underperformance? Take home pay of $1.4 billion.

The Big Fat Pitch

You see, hedge funds are something of a … hmmm, let’s be kind and call this sort of corporate structure a promotional vehicle. The sales pitch goes like this:

‘We have access to information that you don’t; we’re smarter, more knowledgeable and more talented than you when it comes to managing investments; AND we will earn you higher returns than anyone else.’

For the past few decades, wealthy investors and institutions (those who typically have access to hedge funds) greedily swallowed the pitch. And they paid big time fees for the privilege of handing over millions, or hundreds of millions, of dollars to this or that star studded hedge fund.

What kind of fees give investors access to media savvy, hot shot fund managers promising outsized returns?

Fees higher than most any other fund out there. Standard industry practice among hedge funds is what’s known as ’2 and 20 compensation’. Meaning, hedge funds charge fees equal to 2% of funds under management and 20% of profits earned above a certain threshold.

To make this clear, let’s use Dalio’s company as an example. As mentioned, Bridgewater manages a tidy $160 billion. Two percent of that is $3,200,000,000. And Bridgewater skims this ten–figure fee off the top regardless of investment performance. Rise or fall, Bridgewater collects the fee.

Ahhh, but that’s not all that has Bridgewater and other hedge fund managers salivating.

Typically, if hedge fund returns hit 8%, then the fund is entitled to receive 20% of any profits. This is on top of the 2%. The upside here for investors is the incentive. Presumably, Bridgewater strives for returns higher than 8%. If achieved, both investors and funds managers benefit. If not achieved? Well, think of it as foregoing a bonus payment. Because the 2% ($3,200,000,000) isn’t exactly a paltry payday.

So you see, the hedge fund game is even more about attracting money as it is about performance. Because the more money a hedge fund manages, the more guaranteed money it makes.


Are The Gazillions Justified?

Does Dalio, or any other hedge fund manager, deserve such lavish sums for his work?

Well, that depends on your perspective. I mean, here you have Dalio saying, ‘I’m the best at what I do and this is my fee, pay me or take your money elsewhere’. And investors pay. So in this sense, sure, he deserves the money.

It’s not like Dalio is forcing anyone to hand over their money. He’s simply tossing the sales line, and investors are biting. Presumably, these are wealthy, sophisticated investors who have read the fine print, understand the risks, and know the cost.

Okay, sales pitch aside, greed, ignorance and lemming like investor behaviour aside, does Dalio and other hedge fund managers offer substance? Sure, these guys are consummate salesmen, but are they excellent money managers? Do they generate fat returns for investors? Is their alleged talent worth the price?

I can’t answer these questions any better than Warren Buffett who said,

“There is huge money in selling people the IDEA that you can do something magical for them.”



Index Fund Trounces Hedge Funds

In 2007, Buffett made a million dollar bet with Protégé Partner, a New York based hedge fund. You can read Protege’s … uh, um, say, questionable sales pitch here.

The bet was simple: over an extended period of time, an S&P 500 Index Fund (in this case the Vanguard 500 Index Fund Admiral Shares with a, get this … 0.04% management fee) would outperform a portfolio made up of several different hedge funds.

Ten years later, the results are in: Index Fund up 85%. Hedge Funds, 22%.

In the financial world, this is a total wipeout. And it’s largely, though not entirely, owing to fees charged by Hedge Funds. Deducting fees would have seen a return of close to 50%; better but still not even close to a passively managed index fund.

Instead of gloating about his win, Buffett took the opportunity to:

  • Reinforce the fact that excessive investment fees destroy wealth.
  • All investors, including the wealthy, are better off placing their money in a low cost index fund.

And investors seem to be catching on.

In 2016, a record amount of money (close to half a trillion dollars) flowed out of active funds and into passive index funds. Also in 2016, hedge funds saw their first annual outflow of money ($28 billion) since 2009. The reason is simple: high fees and poor returns. Expect the bleeding to continue.

Even If It’s Not a Con, Don’t Believe The Hedge Fund Hype

Though there are active fund managers who are able to consistently (i.e., minimum 10 year stretch) beat passive funds, they are few and far between. As for hedge fund managers, Buffett said it best when rhetorically asking:

“How many hedge fund managers in the past 40 years have said … I only want to get paid if I do something for you? Unless I actually deliver something beyond what you can get for yourself, I don’t want to get paid.”

Of course, no one has said this. Because they do not, and cannot, do anything for investors beyond that which an Index fund may do.

As for Dalio, if huge investor fund flows into passive funds are any indication, it could be that he’s a dinosaur. An absurdly rich dinosaur no doubt. But maybe, hopefully, for the sake of investors, for the sake of fairness, honesty and transparency, him and his kind are on the verge of extinction.







Are Banks Evil?

Sure, I know, the title brings up images of smarmy, briefcase carrying men dressed in pin striped suits, black polished shoes, and a smirk who play the system for their benefit, take risky gambles with other people’s money knowing they can rely on a government safety net to bail them out should any bets turn sour, or turn a blind eye to Rocky Mountain size bags of cash deposits the source of which happens to be drug money proceeds

And the image sticks. Not least owing to gobs of money paid annually to self-professed masters of the universe whose respect is reserved for money and power. Is the image well deserved?

Well, the 99% might think so, not least because the American financial industry was exposed in 2008 as a glorified Ponzi scheme that eventually collapsed and sunk Western economies into the deepest recession since the 1930s. Oh, and those gazillion dollar payouts to the bank’s head shmos?  These certainly do nothing but reinforce the perception that bankers are self-absorbed, greedy, icky people.

Talking Numbers

What kind of money are we talking about? Check out a sampling of recent compensation packages bestowed on the head shmos:

  •  JP Morgan Chase. Jamie Dimon. $27 million (2016)
  • Goldman Sachs. Lloyd Blankfein, $22.6 million (2015)
  • Morgan Stanley. James Gorman, $21 million (2015)

Sure, you could say, are you $%#*&! kidding me? But before you do, know that Gorman’s compensation represents a pay cut of $1.5m, and Blankfein lopped $1m off his total compensation as compared to the prior year. Shedding tears, anyone?

Look north to Canada’s biggest banks, as measured by market value, and you’ll see how poor the Canuck commanders are compared to their American neighbors:

  • TD Bank. Bharat Masrani, $9 million (2015)
  • Royal Bank of Canada. David McKay, $11 million (2015)
  • Scotia Bank. Brian Porter, $11 million (2015)

Do Canadians settle for less because they’re too nice (in that Canadian way) to ask for compensation on par with New York’s elite ? When the numbers are this big, do we care? Not really.

How Much is Enough?

Evil Banker Guy: ‘Hey, BuddhaMoney, there’s always two or more sides to a story, you know what I’m saying? Maybe these guys are rewarded for being the best in the world, top notch leaders who treat their employees fairly, grow their business well and, as a result, benefit shareholders with increasing share value and regular dividend increases. You ever think about that before spouting off?’

You may be right on point there, Evil Banker Guy. Still, if you’re bringing home that kind of dough, you’re rich. Stinking rich. So, in an attempt to understand, because we here at BuddhaMoney like to think, reflect, and understand the world that we live in, I have to ask: what drives a person  to want more and more and more money?

To shine some light on the matter, what do you say we invite into the discussion a certain guy named Warren Buffett. Like the bankers (though he’s not a banker), he too is a rich guy. I’m talking … beyond-your-dreams-it-would-take-thirty-six-lifetimes-to-spend-all-this- money-rich.

For about 50 years, Buffett and his partner, Charlie Munger, have been at the helm of an extraordinary company named Berkshire Hathaway (BRK:NYSE). So extraordinary that if you had bought $1,000 worth of BRK way, way back in 1964, it would be worth more than $11 million today. Holy doodles!

And you know what? For the past 25 years, these two dudes, Munger and Buffett, they’ve been taking home a salary of $100,000. For what they do, that’s peanuts. Nah, peanut shells. No question, they could choose to take soooooooo much more money. But they don’t. And to tell you why, here’s Buffett himself speaking in his 2015 annual letter to shareholders, talking about who will eventually replace him as CEO (Buffett is 86 and still going strong):

“[The next CEO] will be plenty wealthy so don’t complain about pay. And don’t be greedy. It’s important that neither ego nor avarice motivate [the next CEO] to reach for pay matching his most lavishly compensated peers, even if his achievements far exceed theirs.”

Is Buffett a finance / investor / all around human being superhero to me? Ah, come on, you already know the answer to that one.


unknownEnter Buddha

Greed is one of the three poisons. A dangerous toxin; the source for unquenchable thirst for more and more possessions. Greed is often manifested by stinginess, lack of compassion, hoarding or self-indulgence.  When one suffers from greed, one lives in a state of delusion, having become attached to material things, believing that more is better, and that material possessions will bring happiness.


So What If Bankers Are Evil?

Do we care if bankers are evil? I don’t ask the question flippantly. And my intention is not to minimize the impact of rich, powerful people who negatively affect the common good. Because ethics matter. Values matter. Right actions matter. For the individual, the community, society at large. We’re all in this game of life together, affecting each other in small and large ways.

But we BuddhaMoney folks aren’t fond of complaining. When a complainer-whiner-why-aren’t-I-getting-my-share person gets going, they kinda suck the energy out of a room, content to grumble rather than take action to change the situation.

BuddhaMoney folks have a constructive attitude. When they’re ticked off about what’s happening in their world, they size up the situation, brainstorm a plan for moving forward, and then do what needs to be done.

What can you, as an investor, as someone who is building your wealth and your financial freedom, DO about bankers driven by ego and greed?

First, put a smile on your face. Smiles are known to bring about Balance, and other juicy feelings. Second, shrug at the knowledge that some bankers earn more in a year than you will in a lifetime. So be it. Third, to better your financial position, consider BUYING BANKS!

Go Shopping for Banks

As an investor looking for steady-eddy-retirees-can-rely-on-this-and-it-pays-a-healthy-dividend kind of stocks, I’m all for banks. Not just any bank though. You should be picky.

You should invest in financial institutions whose business is largely made up of deposit taking and mortgage lending, who pride themselves on solid risk management, returning capital to shareholders, and have a history of efficient, profitable operations.

In other words, companies that engage in good ole’ fashioned boring, boring, boring banking business. The kind of companies who avoid  business activities that make for screaming headlines, have a long history of increasing dividend payouts, and whose share price gradually increases most years.

And when you find a bank like this, be sure to buy ONLY when shares are on sale. So that excludes the present time given the outrageous run-up in share prices of many financial institutions since the US presidential election. Be patient and wait for a pullback in share price, which is only a matter of time.

Check Your List Twice

If buying individual stocks is not for you, and you want to add specific exposure to the financial sector, then look at Exchange Traded Funds (ETF) such as:

  • iShares U.S. Financials (IYF). This ETF holds shares in 286 financial companies listed on U.S. stock exchanges and charges a management fee of 0.44%.


  • Vanguard Financials ETF (VFH). This ETF holds shares in 402 financial companies listed on U.S. stock exchanges and charges a management fee of 0.10% – Vanguard’s fees are phenomenally low!

For exposure to Canadian financials, review these two ETFs:

  • iShares S&P/TSX Capped Financials Index ETF (XFN).

This ETF holds shares in 27 financial companies listed on Canadian stock exchanges and charges a management fee of 0.55%.

  • BMO S&P/TSX Equal Weight Banks Index ETF (ZEB)

This ETF holds shares in only the top 6 Canadian banks, measured by market capitalization, and charges a management fee of 0.62%. Basically, it’s a bet on the Canadian banking system. That said, if history is any guide, it’s a safe bet given the historical performance of Canadian banks. An investment in this ETF near the end of 2009 would have seen you nearly double your money by today.

If you’re comfortable with the volatility of individual bank stocks, and have a long-term investment horizon, then consider these stocks on the New York Stock Exchange:

  • Wells Fargo (WFC:NYSE)
  • US Bancorp (USB:NYSE)
  • Bank of New York Mellon Corp. (BK:NYSE)

The following Canadian banks are dually listed on the Toronto Stock Exchange and the New York Stock Exchange:

  • Bank of Nova Scotia (BNS:TSE) (BNS:NYSE)
  • Royal Bank of Canada (RY:TSE) (RY:NYSE)
  • Toronto-Dominion Bank (TD:TSE) (TD:NYSE)
  • Bank of Montreal (BMO:TSE) (BMO:NYSE)

Solid Foundation

Keep in mind what I mentioned above: financial stocks have had a wild run since November, 2016, and many are now trading near their all time highs.

Sure, you have some talking heads salivating at the prospect that financials will continue to charge ahead, higher and higher. And that may happen. Still, the safer course of action is to be patient and wait for a market correction before bringing banks into your portfolio. You won’t rake in +$10m/year but if history is any guide, as a shareholder, you will reap the trickle down reward: increasing share price and generous dividend payments. The result being a solid asset foundation and income generator for your portfolio.