Yes. Note: This is a surprisingly accurate description of reality. Aggregate hedge fund returns are goddamn terrible.
> Then why not just invest in an index fund?
Well, you should, if you're trying to maximise your expected outcome. Of course, not everyone is trying to do that.
In particular, what if you run a pension fund which is currently underfunded, but for political reasons is claiming to be adequately funded through the expedient of assuming that future returns will exceed any reasonable expectation of market returns?
If you invest in an index fund you'll get market returns; since that's not enough this means you will miss your targets, and be unable to pay promised pensions, at which point you'll be fired. But if you give all the funds cash to a hedge fund, or engage in some crazy snowball derivative[1], then you'll probably do even worse than an index fund, be able to pay an even lower percentage of the promised pensions, and you'll be fired. Which is actually no worse for you. But you MIGHT do really well, and actually be able to pay the promised pensions. Not likely, but if it works you avoid you getting fired, and if it doesn't you were going to be fired anyhow, so why not give it a shot?
All of why is completely hypothetical. The fact that many US pensions funds are horribly underfunded using any plausible actuarial projects and are simultaneously investing heavily in exotic asset classes is just a funny coincidence.
If the guy generating alpha keeps most/all of his above-market alpha, then that means there's none for me to get or keep, right? I can't see how that's attractive at all.
That's the point. An ability to reliably beat the market is like having a goose that lays golden eggs.
If the ability exists at all, it's certainly very rare. And if you are one of the people who has it, why would you hire that ability out to other people? The guy who owns the golden goose is going to sell the eggs, not rent the goose out. Or if he did rent the goose, it would be for an amount no lower than the expected value of the eggs because otherwise he's losing money.
But given these dynamics, that means that there's no reason to think that if you see some guy offering to rent a golden goose it would be a great deal for you. I mean, he's actively trying to price it so it's not, and it's his goose, so he's probably right.
Yes. Note: This is a surprisingly accurate description of reality. Aggregate hedge fund returns are goddamn terrible.
> Then why not just invest in an index fund?
Well, you should, if you're trying to maximise your expected outcome. Of course, not everyone is trying to do that.
In particular, what if you run a pension fund which is currently underfunded, but for political reasons is claiming to be adequately funded through the expedient of assuming that future returns will exceed any reasonable expectation of market returns?
If you invest in an index fund you'll get market returns; since that's not enough this means you will miss your targets, and be unable to pay promised pensions, at which point you'll be fired. But if you give all the funds cash to a hedge fund, or engage in some crazy snowball derivative[1], then you'll probably do even worse than an index fund, be able to pay an even lower percentage of the promised pensions, and you'll be fired. Which is actually no worse for you. But you MIGHT do really well, and actually be able to pay the promised pensions. Not likely, but if it works you avoid you getting fired, and if it doesn't you were going to be fired anyhow, so why not give it a shot?
All of why is completely hypothetical. The fact that many US pensions funds are horribly underfunded using any plausible actuarial projects and are simultaneously investing heavily in exotic asset classes is just a funny coincidence.
[1]: http://www.bloombergview.com/articles/2014-05-02/portuguese-...