401(k) hedge fund

Hedge funds in a 401(k)? Why aren't future retirees permitted to PROPERLY diversify their portfolios instead of being forced to gamble on stock markets. People need to invest prudently for several decades in retirement. 80 is the new 60 and 100 is the new 80. But what are they going to be ALLOWED to invest in? How can individuals be expected to take responsibility for their pensions when they can't access quality managers, proper diversification or reduce risk with LOWER risk strategies?

Why do regulators feel it necessary to "protect" retail investors from products that most closely align with their actual long term financial planning needs. You can only eat absolute returns NOT relative returns. "Low cost" index funds are expensive considering their abysmal risk-adjusted performance. The risk averse prefer the safety of good hedge funds. Any investor without substantial allocations to skilled absolute strategies has a poorly constructed and overly risky portfolio.

For people in DC defined contribution pension plans it will be their decision as to how to invest from the limited "choice" they are currently given. Many corporate DB pensions are closing to new members. That most, with some exceptions, have failed to use MODERN ways of managing money and hedging risk by investing in ABSOLUTE RETURN is well known. But at least most DB plans are allowed to put money into alternative investments unlike the current DC menu "options".

The 25% ERISA rule is being revamped meaning hedge funds will be able to accept more fiduciary assets, a move that can only help pension beneficiaries and plan sponsors. Anything which lessens portfolio risk, smooths asset/liability funding volatility and dependence on long only stock market speculation should be supported. Long only had their chance and they failed badly. It is time for them to get out the way for superior managers that are better aligned with retirees interests.

Defined benefit pensions generally OUTPERFORM defined contribution pensions. Why? Individual investors pays higher fees, are less diversified and rarely have the experience and advisory resources to construct robust portfolios or pick quality money managers. With self-managed pensions, people must attempt to invest by themselves BUT the best managers are not currently available to them. It is difficult to have a healthy portfolio when the menu is restricted to long only funds.

Regulators seem intent on INCREASING the net worth required to be an "accredited" investor to access skill-based strategies. Most choices available on 401(k) plans continue to be long only index and active mutual funds. No higher quality funds or strategy diversification available for Joe Sixpack or Mom and Pop. Is that a free market? Is that competition? Is that prudent for a fiduciary?

Proper hedge funds are the closest liability match for individual investors saving for retirement. Long only equities are too hazardous and unreliable while bonds and money market funds do not yield enough to generate sufficient capital growth after inflation. Yet hedge funds, the most consistent source of absolute returns, are not available to many that need that performance. Retirees must rely on the stock market with its extended drawdowns and devastating volatility but are excluded from products that BEST suit their requirements.

Don't buy into this "you don't need hedge funds" nonsense that STILL circulates. The 1980s and 1990s were anomalous for stocks AND bonds. Total returns from a simple bond and stock portfolio WERE good but they WILL not be "good" in the future. Reliable absolute returns at low volatility is what retirees need. A diversified portfolio of good hedge funds achieves that. The capital flows from high net worth individuals and sophisticated institutions into hedge funds are occurring for good reason. Superior long term performance.

Strict due diligence, well managed and highly diversified funds of hedge funds, at a minimum, should be available as an option for 401(k) plans. Let people decide what the best place for consistent capital growth is. Why do the regulators restrict retirees from good, low volatility hedge fund products yet continue to permit or even encourage them to speculate their savings away on the stock market rollercoaster? Let the free market decide where people are allowed to grow their pensions. Put good hedge funds on 401(k) menus.

Proprietary trading

Proprietary trading with bank capital is very different to a hedge fund. Recently there have been several multibillion dollar startups by rookies. Good traders maybe, terrific "returns" cited by previous employers with prime brokerage operations eyeing future commissions. Investors are better served if rookies first learnt the business running much smaller amounts as ALL good hedge fund managers did. Avoid firms that raise more than $1 billion "day-one" money. It will take the manager many years to build the necessary experience, if ever.

In the news is a newbie that somehow raised $3 billion by "never having a losing year" at a bank. My due diligence found his past performance was ENTIRELY due to being at that bank, I suspect that now he is on the outside with no edge, he will lose most of it. Another "star trader" apparently produced $700 million "profits" at a bulge bracket firm. My research found he was using $10 billion of bank capital so that is a pathetic 7% from deal flow and client information he won't have access to. Deduct 2% and 20% and apply realistic external commission and leverage costs and there is not much left. My clients won't be touching that one. But the usual clueless funds of funds are piling in!

Bank traders often claim to be "pure" proprietary but usually have access to flow data they would not see at a hedge fund. They often have first refusal on taking the other side of large customer trades, stock borrow locates and distressed asset sales. Stealing ideas, arbitrages and front-running orders never happens? What "commissions" and stock loan fees were they charged while at the bank? Same as an outside client? Leverage is basically an unknown as trades are backed by the balance sheet NOT investor cash. Percentage returns can't be calculated; at best just the profits generated, a number which the trader AND former bank have a vested interest in making look "high".

Often the performance adjusted for return on CAPITAL is surprisingly poor. A seasoned trader with a good street reputation leaving to set up their own hedge fund will lose many advantages and be cut off from information channels that were often crucial to their PAST track record. Let them learn to run a hedge fund on their cash NOT yours. There will be plenty of time to get in later in the unlikely event the fund turns out to be good. If they threaten to "close" to new investors it is even better since you can ignore them and focus on superior hedge funds that are open and run by BETTER hedge fund managers.

Hedge fund shut down?

Robert Merton is shutting down his new credit hedge fund because it "only" raised $30 million. An AUM of $30 million is more than enough to get a hedge fund started and build a track record. Most PROVEN hedge fund managers began with MUCH less. At fees of 2 and 20 that gives him a certain $600,000 each year plus more incentive fees assuming the fund performs which, admittedly, is a very optimistic assumption given his 40 year track record of being consistently WRONG.

Much bigger credit hedge funds have been launched recently. So? The fund would have been nimbler, able to get in and out of positions quicker and act on smaller credit inefficiencies. It is easier to make 20% on $30 million than to make 20% on $3 billion. A smaller credit hedge fund should be able to run rings around the billion dollar behemoths in performance terms. That other funds operate in the space is irrelevant; if his fund does better than the larger ones, investors will redeem from those and allocate to his. At least that is what investors should do.

Considering the total "return" of MINUS 89% that Long-Term Capital Management generated for investors using his models and theories, it is astonishing he could raise any money at all. People do get second chances even when they get it woefully wrong the first time and rightly so. But it is an insult to the investors that put up the $30 million to return it because it is supposedly not enough.

Robert Merton should be delighted he was able to raise such a large amount. Instead of quitting, he could give up his other duties, mail the "Nobel" back to Stockholm so it can instead be given to someone whose work actually deserves it and start focusing on generating returns. He should trade that $30 million - it might EDUCATE him on how markets actually function rather than how they theoretically operate.