According to The New York Times, that game is over. Kaput. Now it’s “speed is money.” In an article entitled, The New Speed of Money, Reshaping Markets, Graham Bowley of NYT writes:

In many of the world’s markets, nearly all stock trading is now conducted by computers talking to other computers at high speeds. As the machines have taken over, trading has been migrating from raucous, populated trading floors like those of the New York Stock Exchange to dozens of separate, rival electronic exchanges. They rely on data centers like this one, many in the suburbs of northern New Jersey.

Hedge funds that build their investment style around the lightning-fast trading technology are known as “high-frequency traders.” But how do they make money trading in and out of securities in nanoseconds? Here’s a video from Marketplace that spells it out:

A few days ago I came across a terrific post by Terry Smith on his blog, Straight Talking. Using Warren Buffett's investment returns, he illustrates why the two-and-twenty standard is egregious. Hedge funds win disproportionately when they charge 2 percent on assets and keep 20 percent of the profits.

Here's what Smith writes:

As you are aware, Warren Buffett has produced a stellar investment performance over the past 45 years, compounding returns at 20.46% pa. If you had invested $1,000 in the shares of Berkshire Hathaway when Buffett began running it in 1965, by the end of 2009 your investment would have been worth $4.3m.

However, if instead of running Berkshire Hathaway as a company in which he co-invests with you, Buffett had set it up as a hedge fund and charged 2% of the value of the funds as an annual fee plus 20% of any gains, of that $4.3m, $4.0m would belong to him as manager and only $300,000 would belong to you, the investor. And this is the result you would get if your hedge fund manager had equalled Warren Buffett’s performance. Believe me, he or she won’t.

 

 

At first I could not believe Smith's conclusion—managers keeping over ten times what their clients make. It was a "say it ain't so" moment. That's why I took a break from college football yesterday to pick through his spreadsheet model.

Bottom line: I can quibble with a few of the model assumptions, but I think Smith's conclusions are right on the money. Hedge fund fees scuk.

Norb Vonnegut

* Scuk means what you think it means—but worse.

In the Public Interest

31. Acrimoney: Norb Vonnegut’s posts are non-fiction and describe the culture of finance, with original and sometimes irreverent commentary about people who manage money or affect it through their political power.

Other notable members on the list include Pro Publica and the Harvard Law School Forum on Corporate Governance and Financial Regulation.

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