History of the Future

Take note historians of the future. When you set out to write your tome, The Rise and Fall of the American Empire, you might find the following three stories, all of them appearing in today's New York Times, to be of interest. They are all symptoms of decadence run amok, the sure sign of a country in decline*:

1. Top Hedge Fund Managers Earn over $240 Million

Combined, the top 25 hedge fund managers last year earned $14 billion -- enough to pay New York City's 80,000 public school teachers for nearly three years.

2. Toyota Overtakes GM in Sales for First Time

Toyota sold more cars and trucks around the world in the first three months of 2007 than any other manufacturer, surpassing General Motors for the first time and ending one of the longest runs of dominance in all of global industry.

3. In Las Vegas, Too Many Hotels Are Never Enough

Even Las Vegas has never witnessed anything quite like what is going on today.
"This is the most outrageous, over-the-top expansion" ever, Mr. Wynn said.

*And I haven't even mentioned our current account deficit.

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IMHO, these articles are just examples of "same thing, different century." Back in the 1800's, pundits (e.g. the author of The Theory Of The Leisure Class) might well have made the same comments based on similar events in their day.

How much did the top railroad company officials (steel magnates, real estate investors) earn from 1840-1900? How many hotels (and houses, apartments, tenements, warehouses and factories) were built in New York City from 1840-1900?

You are a fool. They make so much money becomes they peform vastly useful functions for capital markets. Simons, who took home 1.7 billion uses arbitrage strategies that bring prices closer to equilibrium. The reason we can afford to retire so early, can think about "guranteed pensions" without worry is because these very same pensions are the investors in these fund banks. So are very influential and positive endowments of our finest American university. No doubt you want to enact some legislation to lead us to communism, so that we are all equally poor - because these guys are so rich.

By The Utilitarian (not verified) on 24 Apr 2007 #permalink

I have no problem with rich people or hedge funds. But I have trouble believing that Simons is worth that level of compensation. Maybe he's really decoded the market, in which he's worth many billions of dollars. But that's what they said about LTCM, too. I tend to doubt that any single hedge fund or mutual fund manager is worth such an extreme amount of money and I certainly hope my pension isn't forking over 25 percent of all earnings to him. As the economist Burton Malkiel has repeatedly demonstrated, the past performance of mutual funds is not predictive of future performance. Wall Street has always searched for the secret algorithm of financial success, but the secret is that there is no secret. I'll stick with my low-cost index fund, thank you very much.

Simons does (at superficially) remind me of LTCM, they both used sophisticated mathematical models. For those that don't remember
LTCM was formed by Nobel-prize winning economists, things unravelled in (1997?) threatening to bring down the world economy.

Overall the performance of hedge funds isn't better than their cheaper cousins mutual funds, or their poor relatives Exchange Traded Funds, but they sure make some big bucks for their managers. I'll be glad to play "rocket-scientist" for one if offered the chance.

You don't have to be a socialist to realize that paying 14 hedge fund managers three times more than all of NYC teachers isn't a good allocation of societal resources.

Jonah,

But how then do you determine how much a fund manager is worth? Like CEOs, a very small difference in quality can have a huge impact on the revenue of the organization relative to the salary of the specific individual. Since the fraction that the fund management takes as a cut is transparent to the investors, what alternative to letting competition between funds keep the manager's takes down would produce better results?

Also, you may be misapplying Malkiel's work. The theory that explains Malkiel's empirical conclusions is the Efficient Market Hypothesis, which applies well to publicly traded securities because the information used by traders and the trades are all available. EMH doesn't say that the skill of the predictor is irrelevant, but that the market is dominated by equally good predictors who are doing the best possible with the available information - not suprising, as if you're not familiar with the proper analytical techniques, nobody's going to hire you as a fund manager - so the stock prices reflect the best analysis of the information available. And not every predictor has to be good - a few poor predictors can make it just by buying at market price and holding, but too many poor predictors will ruin the accuracy of the pricing. This is self-correcting because then the EMH won't apply then and it will be possible to distinguish poor predictors.

On the other hand, hedge funds often invest outside of publicly-traded markets - one of their advantages is they have a lot of money and flexibility with what they do with it, so a hedge fund manager will be more likely to be trading in areas where the EMH isn't applicable (prices that are suppressed by liquidity constraints among most investors, offers that aren't available to the general public, models that actually are superior to the industry standards, asymmetric information, etc).

Also, since a lot of stochastic factors play into the returns these guys make, I wouldn't expect the same specific group of 25 managers to pull down $14b again the next year, although it is quite plausible the top 25 earners next time will. Some of these guys will be making relatively modest sums in subsequent years (although still quite a lot in absolute terms; they are hedge fund managers after all).