The Hedge Fund Mirage
The Illusion of Big Money and Why It's Too Good to Be True

Shocking but true: if all the money that's ever been invested in hedge funds had been in treasury bills, the results would have been twice as good.

Although hedge fund managers have earned some great fortunes, investors as a group have done quite poorly, particularly in recent years. Plagued by high fees, complex legal structures, poor disclosure, and return chasing, investors confront surprisingly meager results. Drawing on an insider's view of industry growth during the 1990s, a time when hedge fund investors did well in part because there were relatively few of them, The Hedge Fund Mirage chronicles the early days of hedge fund investing before institutions got into the game and goes on to describe the seeding business, a specialized area in which investors provide venture capital-type funding to promising but undiscovered hedge funds. Today's investors need to do better, and this book highlights the many subtle and not-so-subtle ways that the returns and risks are biased in favor of the hedge fund manager, and how investors and allocators can redress the imbalance.

• The surprising frequency of fraud, highlighted with several examples that the author was able to avoid through solid due diligence, industry contacts, and some luck
• Why new and emerging hedge fund managers are where generally better returns are to be found, because most capital invested is steered towards apparently safer but less profitable large, established funds rather than smaller managers that evoke the more profitable 1990s

Hedge fund investors have had it hard in recent years, but The Hedge Fund Mirage is here to change that, by turning the tables on conventional wisdom and putting the hedge fund investor back on top.

Introduction xi

Acknowledgments xv

Chapter 1 The Truth about Hedge Fund Returns 1

How to Look at Returns 2

Digging into the Numbers 3

The Investor’s View of Returns 6

How the Hedge Fund Industry Grew 10

The Only Thing That Counts Is Total Profits 13

Hedge Funds Are not Mutual Funds 14

Summary 16

Chapter 2 The Golden Age of Hedge Funds 19

Hedge Funds as Clients 20

Building a Hedge Fund Portfolio 22

The Interview Is the Investment Research 24

Long Term Capital Management 27

Too Many Bank Mergers 30

Summary 33

Chapter 3 The Seeding Business 35

How a Venture Capitalist Looks at Hedge Funds 36

From Concept to the Real Deal 38

Searching for That Rare Gem 41

Everybody Has a Story 46

Some Things Shouldn’t Be Hedged 50

The Hedge Fund as a Business 52

Summary 56

Chapter 4 Where Are the Customers’ Yachts? 59

How Much Profit Is There Really? 60

Investors Jump In 63

Fees on Top of More Fees 65

Drilling Down by Strategy 69

How to Become Richer Than Your Clients 74

Summary 77

Chapter 5 2008—The Year Hedge Funds Broke Their Promise to Investors 79

Financial Crisis, 1987 Version 80

How 2008 Redefined Risk 82

The Hedge Fund as Hotel California 85

Timing and Tragedy 93

In 2008, Down Was a Long Way 97

Summary 98

Chapter 6 The Unseen Costs of Admission 99

How Some Investors Pay for Others 101

My Mid-Market or Yours? 104

The Benefits of Keen Eyesight 107

Show Me My Money 111

Summary 115

Chapter 7 The Hidden Costs of Being Partners 117

Limited Partners, Limited Rights 118

Friends with no Benefits 120

Watching the Legal Costs 125

Summary 128

Chapter 8 Hedge Fund Fraud 129

More Crooks Than You Think 130

Madoff 133

Know Your Audience 134

Accounting Arbitrage 101 136

Checking the Background Check 138

Politically Connected and Crooked? 140

Paying Your Bills with Their Money 141

Why It’s Hard to Invest in Russia 143

After Hours Due Diligence 145

Summary 146

Chapter 9 Why Less Can Be More with Hedge Funds 149

There Are Still Winners 151

Avoid the Crowds 154

Why Size Matters 158

Where Will They Invest All This Money? 166

Summary 168

Afterword 171

Bibliography 177

About the Author 181

Index 183

SIMON LACK has spent his entire career in trading and hedge fund investing. After twenty-three years with JPMorgan, he founded SL Advisors, LLC, a Registered Investment Advisor, in 2009. Much of Lack's career with JPMorgan was spent in North American fixed income derivatives and forward FX trading, a business that he ran successfully through several bank mergers, ultimately overseeing fifty professionals and $300 million in annual revenues. He sat on JPMorgan's investment committee which allocated over $1 billion to hedge fund managers and founded the JPMorgan Incubator Funds, two privateequity vehicles that establish economic stakes for emerging hedge fund managers. Lack's financial markets experience dates back to 1980 when he began his career on the floor of the London Stock Exchange.