Hedge funds have been in the news more in recent years due to the downturn in the stock market in 2008. A hedge fund is similar to a mutual fund with one main exception: they focus on a total return, and not a return that is compared to a benchmark average. This return is achieved by engaging in strategies such as short selling, arbitrage, using derivatives and leverage. This strategy of short selling and by taking positions that limit or offset exposure to risk (“hedging”), allows hedge funds to do better in a bear market than normal mutual funds. Generally, these funds have not had to be registered with the SEC, and have been limited to persons with a high net worth. The strategies employed are up to the discretion of the fund manager. There are a number of managers that have made incredible returns for their investors. This leads to the question as to who is the all time best hedge fund manager.
The collapse of the housing industry and overall stock market last year provided the opportunity to see new names as well as some perennial power houses. John Paulson, of Paulson & Co., Inc., seemed like a genius when he bet there would be problems in the mortgage industry. His returns during this period were unrivaled. In a little over a year, his fund went from $12.5 billion to $36 billion which equates to 188% return. While this was impressive, to be considered the best of all time, you must have a longer successful track record.
The Quantum Fund, founded by George Soros is one of the oldest hedge funds still in existence. Soros is known primarily for his currency speculation and as a result is not very popular with certain governments. He single handily was responsible for Black Wednesday (September 16, 1992). This occurred when the British Pound was withdrawn from the European Exchange Rate Mechanism. Soros is known for “breaking the Bank of England,” when he sold $10 billion worth of pound sterling short. He put the whole fund into this position and it netted him a one day profit of $1.1 billion, which represents an annualized return of more than 400%. Soros also had a hand in the Asian Financial Crisis of 1997. He is blamed in part for the rapid devaluation of Southeast Asian currencies. As a reference, the Quantum Fund made almost a 32% profit in 2007.
While there are many capable hedge fund managers, there is one person that has stood above the rest for more than 27 years. James H. Simons started his career as a mathematician before moving into investing. He received his B.S. in mathematics from MIT and his Ph.D in mathematics from UC Berkeley. Simons founded Renaissance Technologies in 1982 and has utilized his background by employing intricate mathematical modeling to carry out trades. They work by analyzing large amounts of data and finding patterns that allow them to predict future movements. About one third of the employees at Renaissance have Ph.D’s. Their Medallion Fund is the most successful of all time with cumulative returns of 2,478.6% for the 11 year period ending December 1999. Looking at it another way, they have averaged 35% annual returns since 1989. Simons is a brilliant person and considered to be one of the smartest theoretical physicists alive in addition to his financial success.
Hedge funds have also received a lot of negative publicity as a result of the ponzi scheme of Bernie Madoff’s firm. There will certainly be more regulation in the future for this industry, and investing in hedge funds is not for everyone. However, if you find a good fund manager, you may be able to achieve significant returns during both bull and bear markets in the United States.
