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Book Review: The Little Book of Hedge Funds
  I have worked for a hedge fund, and I have many friends that work for hedge funds. I understand hedge funds well. The “Little Book” people at Wiley should indeed have done this book, but with a different author. Why? When there are significant areas of controversy around a topic, and you write a [...]

 

I have worked for a hedge fund, and I have many friends that work for hedge funds.  I understand hedge funds well.

The “Little Book” people at Wiley should indeed have done this book, but with a different author.  Why?  When there are significant areas of controversy around a topic, and you write a book as if there is no controversy, it means you haven’t done your homework.

There are many like Simon Lack, who wrote “The Hedge Fund Mirage,” and Dichev and Yu, who wrote “Higher risk, lower returns: What hedge fund investors really earn.” (Note to readers at Amazon.com, if you read this at my blog, AlephBlog.com, you get links to aid your learning.

Quoting from my review of Simon Lack’s book:

But, some of the problems with hedge funds, as a opposed to open-end mutual funds, is that:

1) Many hedge funds go out of business, and as they do, their bad performance is not recorded, and sometimes lost.

2) Hedge funds with good performance give the databases their early performance.  Bad early performance does not get reported.

3) The activity of investors chasing trends is more pronounced in hedge funds than in mutual funds, with a loss of returns of 5% in hedge funds, versus 3% in mutual funds.  This is all due to greater volatility.

4) Double alpha is generally not achievable, because most managers good at longs are not good at shorts, and vice-versa.  Going long and short are different skill sets.

These are issues that the author of the “Little Book” does not address in any significant way.  He mentions Simon Lack’s book once in passing, but doesn’t do anything substantive with it.  He also does not deal with the difference between dollar-weighted and time-weighted returns.  Because hedge funds are often quite volatile, investors buy at the wrong time (after a strong performance), and sell at the wrong time (after a weak performance).  What that implies is that the average investor in a hedge fund typically does worse than a buy-and-hold investor.

Other Problems

  • Page 121 contains a math error in the first example on shorting.  Yo! This is only arithmetic.  Didn’t anyone proofread the work?
  • Page 136 attempts to describe deal arbitrage, and makes what should be an easy concept rather turgid.  It is so unclear, that I would have to assume the author does not understand what is a simple concept.
  • The book does not spend any significant time on how we live in a different world now than in the glory days of hedge fund outperformance.  Even some slight commentary on the limits to arbitrage would have been useful.

Some Strengths

  • Much of the advice that the author gives in selecting hedge fund managers is sound, especially the list of red flags.
  • The “due diligence questionnaire” was also interesting.
  • Most of the descriptive material in the book was accurate, but there are other books and blog posts that provide that information, minus the hype.
  • This book is not mathematical, sometimes to a fault, where a chart or graph could have proven useful.

Summary

To be truly educated about hedge funds, you would need a lot more than this book.  This book reads like you are being pitched on how great hedge funds are; it does not provide enough on the limitations of hedge funds, nor does it interact with the critiques of hedge funds.

Who would benefit from this book: Most investors would not benefit from this book.  Particularly those that advise institutional clients and high net worth individuals would not benefit. It is too optimistic about the performance of hedge funds.  If you want to, you can buy it here: The Little Book of Hedge Funds (Little Books. Big Profits).

Full disclosure: The publisher asked if I wanted the book.  I said “yes” and he sent it to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

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