Masters in Business: Ted Seides on Whether Hedge Funds Are Right For You
Bloomberg's "Masters in Business" episode released on February 5, 2025, features host Barry Ritholtz engaging in an insightful conversation with Ted Seides. As the founder and CIO of Capital Allocators and author of You Want to Start a Hedge Fund: Lessons for Managers and Allocators, Seides delves deep into the intricacies of hedge funds, providing listeners with a comprehensive understanding of their role, benefits, risks, and suitability for various investors.
1. Understanding Hedge Funds
Defining Hedge Funds
Ted Seides begins by tracing the origins and fundamental purpose of hedge funds:
Ted Seides [02:55]: "The original premise of hedge funds was to deliver an equity-like return in marketable securities with less risk than the equity markets."
He emphasizes that the term "hedge fund" has evolved:
Seides [03:20]: "Hedge fund as a term became this very ubiquitous label. ... you have funds that fall under hedge funds that look like that original premise of equity-like returns, and then you have a whole other set that look more like bond-like returns."
2. Media Portrayal vs. Reality
Hedge Funds and Media Sensationalism
Barry Ritholtz highlights the disparity between media narratives and the actual performance dynamics within hedge funds:
Ritholtz [04:13]: "Chasing that performance has led the hedge fund space to swell to over $5 trillion in assets today... But not all hedge funds are created equally."
Seides concurs, pointing out that media often focuses on the extremes:
Seides [04:41]: "Market people do. Well, they revert to the mean. ... The news sensationalizes great performance and lousy performance."
3. Realistic Performance Expectations
Setting Appropriate Return Expectations
Seides advises investors to temper their expectations based on realistic performance metrics:
Seides [04:45]: "If you looked at hedge funds as a whole ... you're talking about like a high single digits number, has nothing to do with 68%."
He cautions against being swayed by outliers highlighted in the press.
4. Sources of Alpha in Hedge Funds
Emerging Managers vs. Quantitative Strategies
Ritholtz introduces the concept of alpha sources, prompting Seides to elaborate:
Seides [06:13]: "In hedge funds... smaller funds have done better than larger funds. ... Platform hedge funds like Citadel Millennium ... have multiple portfolio managers and do a phenomenal job at risk control."
He notes the increasing competition and concentration of assets among top-performing managers.
5. Strategic Allocation and Risk Management
Establishing Clear Processes
Seides underscores the importance of aligning hedge fund investments with overall portfolio strategies:
Seides [07:21]: "Understand what you’re trying to accomplish. ... look for the solution, not the other way around."
Risk vs. Performance
When discussing whether to prioritize performance or risk, Seides emphasizes:
Seides [08:32]: "They are two sides of the same coin, but without a doubt, investors should be thinking about risk first."
6. Evaluating and Mitigating Risks
The Unholy Trinity: Concentration, Leverage, Illiquidity
Seides identifies key risk factors that can jeopardize hedge fund investments:
Seides [09:21]: "Concentration, leverage, and illiquidity ... any two or all three can be a recipe for disaster."
He advises investors to assess these factors meticulously before committing capital.
7. Portfolio Allocation to Hedge Funds
Institutional vs. Individual Investors
Discussing appropriate allocation levels, Seides differentiates between institutional and individual investors:
Seides [10:03]: "Sophisticated institutions ... might allocate as much as 20% of their portfolio. ... for me individually it's about 5% ... to make up for that tax disadvantage."
He highlights that tax considerations play a significant role in determining allocation levels.
8. Fee Structures in Hedge Funds
Evolution of Fees
The conversation shifts to the evolving landscape of hedge fund fees:
Seides [14:33]: "Fees are just determined by supply and demand. ... the 1.5 and 15 is probably around where the industry is."
He explains that performance and return dynamics influence fee structures, moving away from the traditional 2 and 20 model.
Performance-Based Fees
Ritholtz inquires about the viability of performance-based fees:
Seides [15:34]: "Most institutions would be happy to pay high fees for true alpha. ... in new structures, when new capital gets allocated, you do see that attempt to really isolate paying for performance."
9. Navigating Liquidity Concerns
Managing Investment Liquidity
Addressing the issue of liquidity, especially in credit-focused hedge funds, Seides advises:
Seides [12:35]: "Be very careful about what the structure of your investment is. ... ensure that the liquidity offered matches the underlying assets."
He suggests favoring investment vehicles that align with the liquidity profiles of the assets they hold.
10. Concluding Insights and Recommendations
Balancing Opportunities and Risks
Barry Ritholtz wraps up the discussion by summarizing key takeaways:
Ritholtz [16:11]: "If you have a long-term perspective ... and can allocate 5% or 10% to a fund that might be a little riskier... you might want to think about this space."
He emphasizes the importance of strategy alignment, risk tolerance, and sufficient capital allocation when considering hedge fund investments.
Final Thoughts
This episode provides a thorough exploration of hedge funds, demystifying their functions, benefits, and pitfalls. Ted Seides offers valuable guidance for both institutional and individual investors, stressing the necessity of strategic alignment, risk assessment, and realistic performance expectations. Whether you're contemplating diversifying your portfolio with hedge funds or seeking to deepen your understanding of sophisticated investment vehicles, this conversation serves as an essential resource.