$10,000 suits, 200-foot yachts, private jets, and ownership in professional sports teams. If this sounds like a lifestyle you’d want to enjoy, and it probably is, you should consider becoming a billionaire hedge fund manager. One of the glamourous, “smart money” titans of Wall Street…

You could make an absolute killing.

Take Steve Cohen, for example. He’s the Founder, Chairman and CEO of Point72 Asset Management, one of America’s largest hedge funds.

According to Forbes, Mr. Cohen, who also happens to be the owner of the New York Mets, has a personal estimated net worth of $19.8 billion.

In 2023, his fund returned 10.6%…[1]

That’s not bad considering the 20-year average return for the S&P 500 is about 9.69%.[2]

His investors must have been thrilled.

But beneath that expensive private jet veneer and “market beating” return lies something a bit, well, odd.

You see, while hedge fund managers are seemingly fantastic at making money…

They aren’t really all that good at generating returns for their investors. In a moment, we’ll explain why.

But first, according to Citco’s 2023 Hedge Fund Report, the hedge fund industry averaged total returns for investors of about 14.66% last year.[3]

In a “normal” year that may seem quite good considering the long-term average returns of the S&P 500.

However, total returns for the S&P 500 last year were 26.29%. That was nearly double the return of the average hedge fund, and well over double the returns of Point72.

And 2023 was not an outlier.

The American Enterprise Institute looked at hedge fund performance from 2011-2020. They found that typical hedge fund underperformed the S&P 500 “every single year.”[4]

So why is it that a hedge fund’s typical returns do not beat the market, yet hedge fund managers are referred to as “smart money”?

Simply put, they’re smart enough to make money for themselves.

And they make that money… hand over fist.

See, it all comes down to exorbitant fees called the “two and twenty.”

When an investor signs on with a hedge fund, and invests let’s say $100,000, 2% of that $100K immediately comes off the top, leaving the account worth $98,000.

The account is already in the hole before any investment is made.

And, that 2% is an annual management fee. Meaning that at the turn of the next year, the investor will be charged 2%, once again.

Now, with that starting account value at $98,000, every single penny in profit (depending on the agreement) is charged a 20% performance fee.

This means that if the investors account increases by 10% (roughly the average return of the S&P 500), the account would be worth $107,800 (a $9,800 gain) …

Except for those “performance” fees.

When those fees are backed out, that $9,800 drops to $7,840.

Doing some quick math and you’ll see the investor made 7.8% on their money…

While the hedge fund made almost 4% on, well, not their money.

This is what makes hedge fund managers “smart money.” So long as their investors stay invested, they make money.

Clearly, a hedge fund wants to beat the market. Who doesn’t.

But hedge funds aren’t as incentivized to beat that market as you, or I are. You see, no matter what happens (so long as investors stay invested) hedge funds collect at least that 2% management fee…

And don’t ever pay out an “underperformance” fee.

Smart, for them. Not so smart for their investors.

So, how can a self-directed investor beat the average hedge fund?

Well, let’s assume that $100k account again, but this time you’re investing on your own so there’s no “two and twenty” fees.

We’ll use last year’s S&P 500, as well as last year’s average hedge fund returns as an example, as we cannot predict with any degree of certainty what will happen this year (nobody can).

Let’s assume that with your $100k, you invested 50% of it in the S&P 500, reinvesting dividends. That $50k portion of your portfolio would’ve been worth $63,145 at years’ end (less those small transaction fees).

Now, let’s say you invested the other half of your $100k into single stocks. You read some great research reports (like those from SentimenTrader), understood the market cycle and made your picks.

Maybe you hit some homeruns, and maybe you had some serious duds (never listen to the checkout guy at the grocery store), and your performance on that $50k ended up being half the return of the S&P 500 (13.15%).

That portion of your portfolio (less small transaction fees) would have ended the year at $56,575.

In total, between your S&P 500 portion and your single stock portion (with your single stocks lagging the S&P by 50%) …

Your total account value would’ve been about $119,720, a 19.7% total return…

All without the two and twenty, and you’d have beaten the average hedge fund by 34%.

Of course, every year will be different, but historically speaking, so long as you have well researched and actionable information, and you make some “safe” money plays…

You can beat hedge funds as a self-directed investor… and if more of the single stocks “hit” … you could crush them.

But owning a sports team?

You’ll need to collect those two and twenties.

 

 

[1] Hedge fund 2023 returns roll in, including Citadel, D.E. Shaw and Point72 | Pensions & Investments (pionline.com)

[2] Historical Average Stock Market Returns for S&P 500 (5-year to 150-year averages) – Trade That Swing

[3] 2023 Hedge Fund Report – A Year in Review – Citco

[4] You Can Shred the Average Hedge Fund by Doing Basically Nothing. Here’s How. (yahoo.com)