The 2+2 Hedge Fund

[SrGuapo]

Without getting into who I am, I know some things about making money as an investing professional. There are two glaring ommisions here from those arguing that smart people can make lots of money in the financial markets. A lot of you are totally missing the point.

1. You need to separate money made from fees from money made from outperforming the market.

2. You are neglecting the fact that a lot of investment success is a function of luck.

As to point number 1: many of the most successful investors from a compensation standpoint (see the II top paid hedge manager list) make thier money from fees, not from outperforming the market. If you understand how the fee structures work at hedge funds, then you would understand that this is true. You don't get paid to outperform the market, you just take a share of the profits, that's a huge difference. Furthermore, if you have a good year (see number 2), more people give you money, giving you a bigger base of capital from which to extract fees. As long as investors don't care whether you outperform or not (which they usually don't), you continue to generate fees and size. The leverage to this from a fund manager's standpoint is phenomenal. So the money manager does very well financially, but it has nothing to do with his ability to outperform the market, its more a function of the compensation systems in place and marketing. Warren Buffett isn't rich because he outperforms the market, he's rich because his company which he owns a large percentage of, gets a huge market multiple because of Buffett's performance.

As to point number 2: there is a huge luck factor in being able to outperform the market. A few thoughts: both poker and investing are games of incomplete information, but the difference in investing is the access to the information is far from uniform, which gives certain investors edge. This can be outright insider information, or it can just mean having better access because you manage a lot of money, etc. Beyond that, just like in poker, you can get lucky with something. If you are a poker pro, you are going to play thousands and thousands of hands a year. That's a lot of degrees of freedom to smooth out the variance. On the other hand take an investor like Warren Buffett, he has made relatively small amount of financial decisions compared to a poker player. He's been incredibly successful, but part of this could be described as being analagous to Moneymaker or Raymer winning the WSOP. They are fine players, but you have to get a few perfect cards and win lots of coinflips to make it through a field like that. Same thing with Buffett. Look, let's take one million investors, and say 25% of them each year are going to meaningfully outperform the market, and the outperformance is totally random. Over a 10 year period, about 1 person would outperform each year (do the math). Warren Buffett could be this person.

Here is another way of thinking what I am talking about from a poker perspective. From a risk-adjusted standpoint, who did better over the past year, David Sklansky the poker player or David Sklansky the author? Who did better from a risk-adjusted standpoint, Greg Raymer or Pokerstars? Playing poker is not the best way to make money from poker. Same thing with investing.

[SrGuapo]

Without getting into who I am, I know some things about making money as an investing professional. There are two glaring ommisions here from those arguing that smart people can make lots of money in the financial markets. A lot of you are totally missing the point.

1. You need to separate money made from fees from money made from outperforming the market.

2. You are neglecting the fact that a lot of investment success is a function of luck.

As to point number 1: many of the most successful investors from a compensation standpoint (see the II top paid hedge manager list) make thier money from fees, not from outperforming the market. If you understand how the fee structures work at hedge funds, then you would understand that this is true. You don't get paid to outperform the market, you just take a share of the profits, that's a huge difference. Furthermore, if you have a good year (see number 2), more people give you money, giving you a bigger base of capital from which to extract fees. As long as investors don't care whether you outperform or not (which they usually don't), you continue to generate fees and size. The leverage to this from a fund manager's standpoint is phenomenal. So the money manager does very well financially, but it has nothing to do with his ability to outperform the market, its more a function of the compensation systems in place and marketing. Warren Buffett isn't rich because he outperforms the market, he's rich because his company which he owns a large percentage of, gets a huge market multiple because of Buffett's performance.

As to point number 2: there is a huge luck factor in being able to outperform the market. A few thoughts: both poker and investing are games of incomplete information, but the difference in investing is the access to the information is far from uniform, which gives certain investors edge. This can be outright insider information, or it can just mean having better access because you manage a lot of money, etc. Beyond that, just like in poker, you can get lucky with something. If you are a poker pro, you are going to play thousands and thousands of hands a year. That's a lot of degrees of freedom to smooth out the variance. On the other hand take an investor like Warren Buffett, he has made relatively small amount of financial decisions compared to a poker player. He's been incredibly successful, but part of this could be described as being analagous to Moneymaker or Raymer winning the WSOP. They are fine players, but you have to get a few perfect cards and win lots of coinflips to make it through a field like that. Same thing with Buffett. Look, let's take one million investors, and say 25% of them each year are going to meaningfully outperform the market, and the outperformance is totally random. Over a 10 year period, about 1 person would outperform each year (do the math). Warren Buffett could be this person.

Here is another way of thinking what I am talking about from a poker perspective. From a risk-adjusted standpoint, who did better over the past year, David Sklansky the poker player or David Sklansky the author? Who did better from a risk-adjusted standpoint, Greg Raymer or Pokerstars? Playing poker is not the best way to make money from poker. Same thing with investing.

SrGuapo

[Stock Whiz]

Greg/David,

As I have posted before I am long WPTE. Since you two are very close to the industry, what are your thoughts on WPTE?

I believe their online gaming website will be a monster success overseas just by the ability to offer satelites to their WPT tournaments. Also, they are doing an extremely good job getting their brand name out there which should help.

I am a financial advisor and myself and others I know are very bullish on this stock, but would like one (or both) of your opinions. Thanks.

[BadBoyBenny]

[ QUOTE ]
I'm not saying it can't be beat in shorter spurts, but in general, one is better off investing in low cost index funds or spyders.

[/ QUOTE ]


This is very true. But that doesn't mean the market is perfectly efficient. Perhaps we are picking the wrong experts. There are ways to beat the market. They are just beyond the natural abilities and discipline of most everyone. This article help formualte my beliefs. It's worth reading.

http://www.tilsonfunds.com/superinvestors.html

[crazyweasel]

Hm.... a bunch of wannabes gather to discuss where to find fish (aka the bigger fools) and how to squeeze out a few bonus bucks from PartyPoker. Sounds like some real brain trusts involved. Probably the same geniuses who thought they could get rich by day trading until the bigger fools dried up in the stock market. Yeah, that sounds exactly like a crowd I want managing my money [img]/images/graemlins/smile.gif[/img] That said, Barry Greenstein can manage my money anytime.