Masters in Business: Team Favorite At the Money: Are Hedge Funds Right For You?

Bloomberg Radio's "Masters in Business" episode, hosted by Barry Ritholtz, delves into the intricate world of hedge funds. Released on April 9, 2025, this episode features an insightful conversation between Barry Ritholtz and Ted Seides, founder and CIO of Capital Allocators. The discussion navigates the complexities of hedge fund investments, offering listeners a comprehensive understanding of their role, benefits, and risks within a diversified portfolio.

Introduction to Hedge Funds

Barry Ritholtz opens the discussion by highlighting the massive growth in the hedge fund industry, which has expanded to over $5 trillion in assets with projections reaching $13 trillion by 2032. He presses the point that not all hedge funds are created equal and questions whether they are the right investment vehicle for individual investors.

Notable Quote:

"[...] not all hedge funds are created equally. Investors should ask themselves, is this the right investment vehicle for me?"
— Barry Ritholtz (01:11)

The Original Purpose and Evolution of Hedge Funds

Ted Seides explains that the original premise of hedge funds was to deliver equity-like returns with reduced risk through hedging strategies. However, over time, the term "hedge fund" has become a broad label encompassing a variety of strategies, ranging from equity-like to bond-like returns.

Notable Quote:

"The original premise of hedge funds was to deliver an equity like return in marketable securities with less risk than the equity markets. So literally hedged funds, a fund that had some hedging component that would reduce risk."
— Ted Seides (02:15)

Performance Expectations and Media Perceptions

Ritholtz brings up the media's focus on top-performing hedge funds, which often creates unrealistic expectations among investors. Seides cautions that while the media highlights extreme performances, the majority of hedge funds perform closer to average market returns.

Notable Quotes:

"Those expectations should be more modest than what you might read in the press."
— Ted Seides (03:33)

"If you looked at hedge funds as a whole and try to get at, let's say that equity, like expected return, you're talking about like a high single digits number, has nothing to do with 68%."
— Ted Seides (04:05)

Alpha Generation: Emerging Managers vs. Quants

The conversation shifts to the sources of alpha within the hedge fund space. Seides notes that emerging managers and quantitative strategies are primary drivers of outperformance. However, as the industry grows, maintaining high performance becomes increasingly challenging due to increased competition.

Notable Quote:

"In all of asset management there's this aphorism size is the enemy of performance. It's certainly been true in hedge funds that generally speaking, for a long time smaller funds have done better than larger funds."
— Ted Seides (05:33)

Evaluating Opportunities: Process and Prioritization

Seides emphasizes the importance of having a clear process for evaluating hedge fund investments. Investors should first define their portfolio objectives and then select hedge funds that align with those goals, rather than investing impulsively.

Notable Quote:

"You need to understand what is it you're trying to accomplish through that investment and then go look for the solution, not the other way around, just by saying, oh, hedge funds are a good thing, let me go invest in them."
— Ted Seides (06:41)

Risk Management: Prioritizing Risk Over Performance

The discussion underscores that risk management should take precedence over chasing performance. Seides argues that understanding and controlling risk is fundamental to successful investing, particularly within hedge funds.

Notable Quote:

"They are two sides of the same coin. But without a doubt, investors should be thinking about risk first."
— Ted Seides (07:52)

Historical Risks and Evaluating Current Risk Structures

Referencing the collapse of Long-Term Capital Management, Seides outlines three critical risk factors: concentration, leverage, and illiquidity. He advises investors to evaluate hedge funds based on their exposure to these risks to avoid potential disasters.

Notable Quote:

"There are three pillars that don't go together well, concentration, leverage, and illiquidity. You can take any one of those risks, but if you take two or certainly three at the same time, that's a recipe for disaster."
— Ted Seides (08:22)

Capital Allocation: Determining the Right Percentage

Seides provides guidance on how much capital investors should allocate to hedge funds. For sophisticated institutions, up to 20% of their portfolio may be allocated, whereas individual investors might consider around 5% due to factors like tax inefficiency and higher risk.

Notable Quotes:

"For me individually, it's about 5% because I need to feel like the managers are so good that they can make up for that tax disadvantage."
— Ted Seides (11:00)

"You're probably in the double digit millions."
— Ted Seides (10:46)

Liquidity Concerns and Investment Structures

Ritholtz raises concerns about liquidity, particularly when hedge funds impose gates or restrictions on redemptions. Seides advises investors to ensure that the investment structure matches the liquidity of the underlying assets to mitigate such risks.

Notable Quote:

"You need to make sure that whatever that hedge fund manager is investing in is appropriate for the liquidity that they're offering."
— Ted Seides (12:34)

Performance Post-Financial Crisis and Fee Structures

The episode examines the performance trends of hedge funds post the 2008 financial crisis. Seides observes that increased competition has made alpha harder to achieve, leading to a concentration of assets among top-performing managers. Additionally, fee structures have evolved, with the traditional "2 and 20" model becoming less common in favor of more performance-based fees.

Notable Quotes:

"You don't see a lot of 2 in 20. And part of that is that fees are just determined by supply and demand."
— Ted Seides (13:53)

"In new structures, when new capital gets allocated, you do see that attempt to really isolate paying for performance."
— Ted Seides (15:31)

Conclusion: Weighing the Pros and Cons

Barry Ritholtz concludes the discussion by summarizing the key takeaways. Investors should maintain a long-term perspective, allocate a reasonable percentage of their portfolio to hedge funds, and carefully evaluate strategies and liquidity needs. He advises awareness of the challenges in accessing top-tier funds and underscores the potential benefits of diversification and enhanced returns when approached thoughtfully.

Notable Quote:

"If you have a long term perspective and you're not awed by some of the big names and rock stars who occasionally put up spectacular numbers, and you're sitting on enough capital that you can allocate 5% or 10% to a fund that might be a little riskier and have a little higher tax effects, but simultaneously could diversify your returns and could generate better than expected returns, you might want to think about this space."
— Barry Ritholtz (15:31)

This episode serves as a valuable resource for investors contemplating the addition of hedge funds to their portfolios, providing a balanced view of the opportunities and challenges inherent in this investment vehicle.