Interesting angle on the story that we seem to be seeing every day: Shock! Horror! God-like hedge fund managers can't beat the market every single month. Not a problem that Bernie Madoff had...in fact I'd love to see the likes of Paulson dismissing their clients' concerns by explaining that you have to lose money every once in a while to prove that you're not a fraudster. Maybe Steve Cohen should make sure that he has a bad year to get the SEC off his back.
Anyway, AR suggest that Paulson et al. maybe be losing money because they're running too much of it. Yes, the performance of some managers may benefit from the tailwind of asset growth, which can reverse, BUT if Paulson had the ability to forecast the strength AND TIMING of any recovery, there are enough liquid markets out there to turn this prediction into cash. A small cap stock manager faces very obvious capacity constraints. But if I think growth will beat expectations, I can trade some serious size in bonds, FX, commodities and large cap stocks.
The questions you have to ask of Paulson should be based on these facts (I probably shouldn't use the word facts as I'm using my second-hand knowledge of the situation, but I'm a blogger so deal with it):
1) The bulk of Paulson's track record is in event-driven investing, focusing on stock-specific situations
2) He grasped someone else's idea (what?! Johnn Paulson did not invent the concept of shorting subprime securities?!) and raised a lot of money to bet on one of those rare things: a situation where potential losses are limited but potential gains are huge. The skills it takes to go short subprime securities (or make money from event-driven investing) are not the same as those required to accurately predict the strength of an economic recovery. Whatever kind of due-diligence anyone claims to have performed, what they have actually done is said "Paulson is so smart, I will just give him some money and I will get rich."
The situation regarding investors who have stayed within their area of expertise, i.e. stockpicking for people like Bill Miller or Bruce Berkowitz is different. But as someone called Denis Bastin says in the FT, “You cannot seek out short-term performance and expect good long-term returns.” Earlier in my career, a very, very smart investor told me that in this business, you have to deal with the fact that being good may mean you are only right 51% of the time. There do seem to be some traders who can beat the market year in, year out. But most of the great investors have had periods or underperformance.
I will end now with something that is a complete waste of time and will have not effect on the vast majority of investors: some common sense.
In order for a manager to beat the market, they have to risk underperforming. If you give someone else your money to invest, only their skill, approach, hard work and access to information will determine their success. If this changes, fire them. If this doesn't change and they underperform there are only two possible outcomes: you have confidence in them and recognise that their approach will work in the long run; you are not confident that they have the potential to beat the market in the long term so you made a mistake in selecting them and you should fire yourself because you are bad at selecting managers.
