Confessions Of A Hedge Fund Manager

The Motley FoolWhat do you call a room full of hedge fund managers? Could it be an academy of hedge fund managers? Or maybe we should call them a college of hedge fund managers.

Whatever we eventually decide upon, these professional money men are supposed to represent some of the finest brains in the finance industry. Thing is, hedge fund managers need to be smart. They are expected to spot immediate opportunities in the market that the rest of can’t see in a month of Sundays.

Too clever by half

What’s more, through complex trading strategies that include short-selling, options, futures, arbitrage and a hefty dollop of leverage, they are supposed to deliver not just any old return but, more specifically, absolute returns. In other words, the returns are not meant to be dependent on the direction of the market.

Now, that is clever.

So even if the market is going up, hedge funds aren’t supposed to simply buy shares in the bull market. By definition, that would not be an absolute return. That is because the returns would then depend on the direction of the market.

Does that make sense to you? No? Well, it doesn’t make a whole bunch of sense to me, either. But then I am just a simple Fool – a Motley Fool – who believes in investing in good companies for the long term.

Something in the air

I was recently invited to a private seminar in Singapore at which an old acquaintance, hedge fund manager, Lars Kroijer, was the guest speaker. The audience was primarily made up of hedge fund managers.

You could almost smell the neural activity in the air. At least that is what I think the smell was.

It was a fascinating speech about the trials and tribulations of a hedge fund manager. Everything that Lars said made sense. That is provided you were perfectly comfortable with alphas, betas, Capital Asset Pricing Model and enjoy going long on a bit of this, whilst shorting a bit of that at the same time.

As far as I am concerned, an alpha is a posh Italian car, a beta is a website that is still in testing mode and a short is what happens when I wire up a plug the wrong way and the lights suddenly go out.

Lars’ seminar was going swimmingly until he dropped the bombshell of the afternoon. He told the audience that most investors, including professional money managers, cannot beat the market.

His argument was that for most investors, handing money to fund managers did not make sense. He has a point. For most people, a better option would be to buy the widest possible basket of shares and keep adding, adding, adding money to the basket over time.

How to beat the market

Warren Buffett said as much when he intimated that a very low-cost stock market index tracker is going to beat a majority of the amateur-managed or professionally-managed money. He added that the gross performance may be reasonably decent but fees will eat up a significant percentage of the returns.

The clue to underperformance is fees. Regularly buying and selling shares will add to your cost of investing. Whilst the cost of investing is unavoidable, it can be controlled if we just buy and sell less often.

For me, that has always been the key to outperforming the market. Simply look for good companies that you can buy to hold for the long term.

Since the turn of the Millennium, the Straits Times Index (SGX: ^STI) has delivered an annual total return of around 4.2%. That’s not too bad. But companies such as Keppel Corporation (SGX: BN4), Sembcorp Industries (SGX: U96) and Jardine Matheson (SGX: J36) have delivered returns that are around three times higher.

So, it has been possible to beat the market. But that is provided you choose shares that have solid business models and sound management behind them. Additionally, resist the temptation of dipping in and out of the market.

Timing the market will inevitably increase your investing cost. But time in the market should increase your investing returns.

This article first appeared in Take Stock Singapore.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.