By the way, thanks a lot for making this, Jeff. I've been using your feeds almost daily since August. I used to spend a lot of time scanning the /best page for unread articles. No more!
Hedge funds charge high fees, but a subset of them provide a product you can't get anywhere else: returns orthogonal to other investments. Sophisticated investors pay happily for it. What's being stolen?
I think what jeffmiller meant was that an investors returns from a hedge fund investent should have very little to no correlation to other investments the investor has made.
Or more generally, that hedge funds can be structured for their returns to bear little to no relation to the stock market as a whole. They do this by making highly leveraged bets in both directions. (Buy an option for 10 cents on a stock that rises from $4.00 to $4.10. Bam, 100% profit. Or 100% loss if the stock does not rise at all.) This action is called hedging, giving hedge funds their name.
The dirty secret is that hedge funds do not work long term. The stock market goes up on average over time. A hedge fund that does not correlate with the stock market has no guarantee or even reasonable expectation of doing so. The stock market rises over time because its constituent companies create wealth, by building or manufacturing things. Hedge funds have no such underlying creator of wealth. The only way a hedge fund makes money is to find a bigger fool. For every highly-leveraged gain, somebody else lost the same amount by possessing or acting on less information.
Some hedge funds actually do achieve consistent gains by technical means, as the original article touches on. They can have the fastest computers closest to the exchange trading centers, that can beat other investors to attractive offers by fractions of seconds and/or pennies. There's no secret cabal conspiracy there though. Profit is the only motive; any apparent manipulation is just the result of everybody acting in self interest.
