A lot of talk about ‘smart money’ is a myth. Who specifically is it? Name them in advance. Tell me (Forbes of whoever), who will outperform the market for the next 3 years.
I am invested in a long-short fund from QIM. They take directional bets on market direction. They have averaged 20%+ returns with a 1+ sharpe since inception in early 2008. I invested in Jan. 2009. Their largest DD before this year was 15% or so. They are clearly smart money on paper. They went short big in October of this year and lost 15% in 1 week.
However, I also invested in their Global Fund (redeemed this summer). They were named one of the best Global Macro traders in the world by many magazines in 2008 after 7 years of huge returns - including 2008. And had a 1+ Sharpe ratio. Since 2009 they have averaged about -2%/yr.
This same group launched then closed another fund (after it lost 15% or so in its first year).
LJM is one of the best long-term option traders around with a track record of 10 years or more. They lost 17% or so this past September in their most aggressive program and 12% in their basic program (they are still a very good fund, but down about 2% on the year). ( I am not invested).
Or look at the Barclay Hedge Fund index. These are the aggregate returns of all reporting funds in the Barclay’s index without (with a likely survivorship and reporting bias that inflates how well an investor would have done by 2-4% / yr). I have beaten this index by a lot on a risk adjusted basis since I started using P123. (Although some of my R2G’s haven’t since launch, unfortunately - and I feel bad about that).
See:
http://www.barclayhedge.com/research/indices/ghs/Hedge_Fund_Index.html
These funds tend to track around the same volatility and peak DD’s as a 60/40 portfolio. They have done about 2% this yr, but have underperformed the 60/40 portf. for a long time now. In fact, you have to reliably select top decile hedge fund managers to make money. This takes real time and the vetting of 100’s of managers by a skilled team. So, if all hedge funds are not ‘smart money’ who is?
Maybe Victor Niederhoffer. He averaged 35% / year over more than 20 years. And was voted the #1 Hedge fund manager in the world in 1996. Then he lost 100% of all his money (and his funds’ money) in 1998 or so. Then he clawed back and had amazing returns until 2007 or so. Then he lost 75% of his investor’s money and had his fund shut down. See:
http://en.wikipedia.org/wiki/Victor_Niederhoffer
He’s smart money. Right>
Or maybe it’s John Paulson. He pulled off the biggest most possible trades ever (at least top 5) in 2008 betting against subprime in a huge way - and had 2 decades of steady double digit returns with no losses prior to that. Since then he’s down huge, including 40% losses in 2011. This year he’s down 14% or so. See:
http://www.forbes.com/sites/nathanvardi/2014/10/09/hedge-fund-billionaire-john-paulsons-comeback-crashes-in-september/
So, people say smart money. And we can always find a handful of traders doing great. But, with the thousands of funds launching we can’t say if this is skill or luck. And many of the ‘best’ blow up or significantly underperform after cash inflows.
So, yes, if you are trying to compete against hi frequency traders, you are likely to lose. Judgetrade is right. But if you are buying and holding for 1-3 months at least - or competing in liquidity spaces they can’t - and you KNOW your advantage, you have a very good shot of outperforming hedge fund investors over long periods.
Or what about Warren Buffett? He did 35% plus returns early on over 3+ decades. But from roughly 1998 to 2013, you would have beaten him handily - over more than 15 years - by buying a value index fund - or equal weighted basket of small value stocks. See: http://www.marketwatch.com/story/warren-buffett-more-myth-than-legend-2013-07-03?page=2. He also has significant (very low cost) leverage that we previously didn’t get. Isn’t he smart money? He’s using no timing. But, he’s had a rough 15-20 years (I haven’t updated this - but did look at it at the beginning of last year).
‘Smart money’ is a tool of lazy reporters. They either just use the term when they don’t know who it is - or ‘annoint’ one or two people. However, most of these people then fail ‘out of sample’ if you track them long enough. Even for those who don’t it’s very hard to determine if it’s luck or skill. So many start the game, that even ‘random dart throwing monkeys’ - would show some winners after a decade. In fact, if we start with 10,000 managers and half make money annually by chance. 313 have made money every year after 5 years and 9 people after 10 years. Now, if they have some specific style and that style does well, the run can last longer. Or if people offer multiple programs and ETF’s and mutual funds, the same thing can happen.
A lot of hedge funds simple beat investors by charging 2/20 while investing their own money in ST T-bills (seriously), land and rental properties. They launch a lot of funds until something hit and then raise as much money as they can. R2G may or may not be different than that. Only time will tell. But, using P123 to find lots of different investments, controlling risk, knowing your advantages (and blending baskets of ideas) and holding down costs is something that can be profitable.
Try to find diversified return streams. The question becomes what do you (we) really believe in and can stick with for a decade. Chasing the latest ‘fad’ is a losing recipe. And why most retail investors significantly underperform buy and hold (by 3-5%/yr). The same will (likely) be true of unsystematic chasing of P123 strat’s.
Best,
Tom