Is the Stock Market Rigged? Is Rain Wet?

More than 50 percent of U.S. investors believe the stock market is rigged, according to a Bankrate survey. When you look at the wild price swings of a stock like ViacomCBS, exacerbated by massive trades that backfired on a family hedge fund and shook the investment banking world, the obvious question arises:

Why isn’t it 100 percent? 

Ray Dalio's “Slightly Better” Returns

Now that real life has blended with reality TV, you can't blame the Main Stream Media for stressing out. Still, this lengthy NY Times piece on Ray Dalio, who runs Bridgewater, world's biggest hedge fund firm, seems a bit snarky. For instance:

Since it began, Pure Alpha has made investors an annual average return after fees of 11.9 percent, slightly better than the 9.5 percent average yearly return for the Standard & Poor’s 500.

Slightly better? Any stock picker who can beat the S&P by one percentage point over long periods is

Bridgewater's Westport, CT headquarters

exceptional. Two percentage points? Almost miraculous. With Pure Alpha Dalio has done better by 2.4 percentage points. Compare:

At the S&P's 9.5% average annual return, in ten years a $100,000 investment grows to 247,823.

At Pure Alpha's 11.9%, in ten years a $100,000 investment grows by an additional $60,000, to $307,823.

Over extended periods, that "slightly better" return will make you seriously richer.

What $150 Million Will Buy

Roy Lichtenstein’s “Masterpiece” (1962)

To raise money for a philanthropic fund aimed at shrinking the alarmingly high percentage of Americans who spend time in prison, the president emerita of the Museum of Modern Art has sold her prized Lichtenstein for $150 million ($165 million including fees).

The buyer: Steven A. Cohen, the once-and-future hedge fund tycoon. After scraping past insider-trading charges but being temporarily sidelined from the hedge fund business, Cohen's next masterpiece will be a new, $20-billion hedge fund to be launched next year.

Connecticut's Golden Geese Cash In

New Jersey's Tax Problem is that a few taxpayers make so much money they become golden geese – the State treasury can scarcely get along without them.

It's happening in Connecticut, too, as Jim Gust commented.

Bridgewater Associates headquarters, Westport, Connecticut

Connecticut's golden geese include Ray Dalio, the founder of the world's biggest hedge fund. Last year Bridgwater's chief enjoyed an income of $1.4 billion. Two of his lieutenants each made $250 million.

With immense incomes comes king-size clout. The State of Connecticut has come up with $20 million to discourage Bridgewater Associates from moving out of state.

New Jersey's Tax Problem

If you owe the bank $100 that's your problem.

If you owe the bank $100 million, that's the bank's problem.  

– J. Paul Getty

 Hedge-fund billionaire David Tepper was the richest taxpayer in New Jersey. He's still rich, but …One Top Taxpayer Moved, and New Jersey Shuddered.

If Congress Won't Tax Carried Interest as Income…

. . . maybe New York and neighboring states should pick up the "lost" revenue. By collecting the equivalent of what hedgies save by having the carried-interest portion of their compensation taxed as capital gain, New York State figures it might collect $3.7 billion a year. For New York's ploy to work, neighboring states would have to follow suit. It's suggested that The Merrill Anderson' Company's home state, Connecticut, could collect a half billion or so annually. See New York Challenges a Tax Privilege of the Rich.

You're a Hedgie? How Embarrassing!

Way back when, I avoided mentioning my job in market research. Too embarrassing. Now hedge-fund guys and gals face a similar problem. Subpar returns lead to poor image, and poor image leads to dissembling.

"Mentions of hedge-fund employment in marriage announcements have declined by 20% since 2007," reports Rob Copeland in The Wall Street Journal. 

Out of more than 8,000 hedge funds, "only 1,176 firms use the term hedge fund in the 'about us' section of their SEC investment adviser registration."

Favored euphemisms for hedge fund:

Alternative asset manager
Investment holding company
Private partnership

Can rebranding save the day? 

How to Profit From Hedge Funds, Continued

New York Post: Hedge funds had a horrible year, but managers are billionaires.

How to Profit From Hedge Funds

Thirty-one members of the 2014 Forbes 400 derived their fortunes from running hedge funds.

Passive Investing vs. Pricey Investing

Vanguard Reaches $3 Trillion In Assets, Matching Entire Hedge-Fund Industry

Active Investing: The Happiness Quotient

On average, passive investing produces better returns than active investing. In a rational world, shouldn't active investors become extinct?

No. The economic benefits of active investing aren't limited to the net returns after fees, trading costs and taxes. While passive investing is as exciting as watching grass grow, picking stocks is interesting, challenging and sometimes even fun.

Thus, the benefits of active investing include the net return plus a happiness quotient.

A happiness quotient? The economic concept emerges in a cost-benefit analysis of smoking tobacco. Smoking's costs include increased risk of lung cancer and a shortened life expectancy. However, the estimated happiness benefit – the pleasure of smoking – offsets an estimated 70 percent of the cost. (Critics argue that the percentage is too high.)

In the context of investing, the economic value of the happiness quotient should be easier to compute. If hedge-fund investors settle for  an average return of 9 percent during a period when the S&P is returning 12 percent, the economic value of their happiness quotient must be at least 3 percent.

Can Three-Second Trades Produce Long-Term Capital Gain?

With a ploy called "basket options," a hypertrading hedge fund claimed billions of dollars in tax savings. The Senate Permanent Subcommittee on Investigations seems impressed.

The Great Hedge Fund Mystery

Why do hedgies make so much? The New Yorker's John Cassidy can't figure it out. He asks for help.

Remembering Alex Porter and “Hedged” Funds

Alex Porter, who worked at the first hedge fund, A. W. Jones & Co., and later ran his own successful firm, died April 18.

As one of “the last practitioners from the A.W. Jones era,” Porter carried the long-ago notion of a “hedged” fund as one that is “long and short and thereby inured to the vicissitudes of the overall market,” said James Grant, a friend and colleague who publishes Grant’s Interest Rate Observer. 

Today, by contrast, the term “hedge” suggests “leveraged and long” investing, he said, which often amplifies rather than cushions market swings.

For Porter, less volatility didn't mean lesser performance. From 1976 until 1993, his first fund reportedly generated a net compound annual return of about 20 percent .

Has Investing Reached a Fork in the Road?

Within living memory, investing has evolved in three stages:

 SS

 Stock selection was the key after World War II. Fifty years ago Shearson boasted of its stock-picking
task force: "Last year they traveled more than 350,000 miles, studied more than 10,400 annual reports and held more than 5,400 interviews with company executives."

Then efficient market theory came along. All that analytical work, it seemed, was pointless. On average, stock pickers produced only average results. And that was before commissions.

AA

Asset Allocation reflected the finding that investment returns depended mainly on how funds were deployed among different asset classes. Selection of  specific securities was secondary. Thanks to index funds, followed by similar ETFs, asset allocation became simple, efficient … and deadly dull.

Efforts to spice up AA by creating dozens of asset sub-classes ("I'm tweaking my Chinese midcaps and dumping Irish micros.") didn't help much.

II 

Irregular Investments – less alliteratively, alternative investments – avoid the shortcomings of both SS and AA. Markets are less efficient in the II world, and private equity deals appeal to investors who want to feel they've entered the big leagues.

"Hedge funds, private equity, and private debt are being extolled as some of the best ideas for wealthy investors' portfolios in 2014," according to this Barron's cover story. (I gained access; results for other nonsubscribers may vary.) As shown here, Goldman Sachs is putting 14% of clients' money into private equity. GenSpring puts a full quarter of client assets into hedge funds.
 
As an investment method for the 1%, irregular or alternative assets are winners. Clients feel special. Wealth managers harvest hefty fees. But for lesser investors, a competing approach is gaining ground.

CC

Cost Control. Even if most funds and portfolios typically produce more or less average returns, investors can gain a sure-fire edge by lowering their costs. Jack Bogle, of Vanguard fame, has proselytized for cost control for years. His latest salvo: The Arithmetic of “All-In” Investment Expenses.

Even one-percenters can be tightwads when confronted by today's investment fees. Stuart Lucas, for example, believes investors should focus on what they net after expenses and taxes.

Stuart E. Lucas, chairman of Wealth Strategist Partners, which manages about $1 billion for a small number of wealthy families, analyzed state and federal taxes along with management fees to argue that if 50 percent of your return went to someone else, then you should reconsider the investment.

Index funds and most mutual funds are under the 50 percent line. Hedge funds are always above it for a taxpaying individual. Private equity investments are on the line.

 Will pricey Irregular Investments prevail as hedge funds seek to expand their customer base beyond the 1%?  Or will the 1% decide hedge funds are so yesterday and boost their returns by cutting expenses? We'll be watching.

“We Do the Insider Trading So You Don't Have To”

That's one suggested slogan  – "more truth than poetry," as my mother used to say – for hedge funds as they begin marketing to the millionaire next door. Others include:

"Trades great, more billing."

"Alpha for the rest of us."

"Hedged today, gone tomorrow."

"Fee all that you can fee."

Warren Buffet has marveled at the willingness of investors to believe that higher fees will produce superior performance. Nevertheless, hedge funds remain the place to put your money when you care enough to pay the very most.

Wall Street's Fungal Creep

Heidi Moore's tirade against the push to advertise hedge funds may be a bit over the top, but she does have a way with words:

For most people in the US, Wall Street is not an everyday concept. It's more like a haunted Victorian mansion on the edge of town where your 401(k) retirement plan lives: it takes a long time to understand how to get there and you're pretty sure something's not right about it, but you're too scared to get close enough to check. ***

As you might expect, that's an illusion. Wall Street is in your backyard … in your schools and roads … in your bank account, charging you fees on your checking account ;…[and] in your driveway, where your car sleeps as you pay off your auto loan – a debt that has already been sliced and diced and sold to a trader at a bank somewhere. ***As a result, Wall Street is not so much like a haunted Victorian mansion as a quiet, creeping fungus right where you live: it grows fast and takes root everywhere, silently.

Moore may be right about the targeting of seven-figure 401(k) balances. Still, Wall Street already markets 10,000 mutual funds and a thousand or more exchange-traded funds. The 8,000 or so hedge funds, most of which underperform the S&P, will have plenty of competition.

One quibble: Contrary to Moore's assumption, the U.S. has nowhere near nine million millionaires. We have about nine million millionaire households. The number of individuals with investable assets of $1 million or more is closer to three million. 

Kicking Hedge Funders When They're Down

Ouch! The Hedgies of Greenwich and elsewhere on the Fairfield County Gold Coast must be wincing. BloombergBusinessweek delivered a swift kick to their tender areas, complete with a cover illustration you've surely heard about.

OK, the average hedge fund underperforms the market. Does referring to "average hedge fund"make any more sense than talking about the "average teenager?"

Anyhow, performance isn't everything, as Josh Brown points out in his rebuttal to Sheelah Kolharkar's Businessweek story. Some high-net-worth investors crave status symbols more than alpha.

The BloombergBusinessweek story is timely because hedge funds are gaining the ability to advertise directly to the public. Theoretically, that public is limited to millionaires. (Hedge funds generally aren't supposed to deal with lesser mortals.) Still, over-aggressive marketing could move hedge funds into the financial mainstream at the cost of their "luxury" cachet.

Suppose Money magazine starts featuring "This Month's Five Hottest Hedge Funds." Might wealthy investors decide they'd rather have a Rolex?

The Most Expensive Home In Hedge Fund Country

This Greenwich mansion is the most expensive home for sale in the United States, according to Ocean Home. Asking price: $190 million.

The realtor describes the 50-acre estate as incomparable in Greenwich, where hedge funders go when they become billionaires.

Enjoyed by the noted Lauder Greenway family from their purchase of it in 1904….. This incomparable estate, 40 feet above mean high water, owns two islands and altogether they have a total of almost a mile of shorefront, amazing views, extraordinary walled gardens, unbelievable privacy, a 75 foot pool with a spa, a beach, a grass tennis court, a superb greenhouse, a stone carriage house and a cottage….

Asking $190 million isn't the same as getting it, these days. Before the real estate crash, even the Greenwich sky wasn't the limit. Nina Munk evokes the era in this 2006 essay for Vanity Fair.

Now even one of the Greenwich hedge fund greats, Steven A. Cohen, is besieged by the SEC.

Former Hedge Fund Manager Arrested

… in the Uffizi Gallery in Florence.

"Florian Homm, a flamboyant former hedge fund manager who spent the last five years in hiding, was arrested in Italy," the NY Times reports. He faces extradition to the United States on securities fraud charges,