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Guest Post: When Will Capitalism Come To Wall Street?

Tyler Durden's picture




 

Submitted by Omid Malekan via Visual Stories blog,

Ralph Waldo Emerson once said “Doing well is the result of doing good. That’s what Capitalism is all about,” and nowhere is this description more embraced than on Wall Street. There, the idea of the meritocracy, where those that produce the most financial value get to take home the biggest rewards is almost a cliche  All of which begs the question, why do most hedge funds exist?  If Capitalism existed on Wall Street, and compensation was tied to the creation of economic value, most of the “absolute return industry” would go out of business. To understand why, we need to go back a decade.

Back in the Spring of 2005, I and my boss at the small fund where I worked had a meeting with the manager of a large fund of hedge funds, an entity whose function is to farm out investor capital to different hedge funds. The manager had brought a printout of the prior months returns of every fund they invested in, looking to answer a pressing question. In the prior month the stock market had had a small selloff, and for whatever reason, the majority of hedge funds they invested in had lost money.

The manager was confused, and so were we. Hedge funds were invented to make money regardless of what the markets were doing, and up until then, they mostly did. The industry came to fame amid the ashes of the 2000 to 2003 equity bear market, where hedge funds demonstrated they could make money in a falling stock and interest rate environment. That’s why towards the front of almost every fund’s private placement memorandum there is some language on not being too correlated to the movements in any market, and how the goal is to make a steady stream of income in any financial environment. In other words, the ability to generate an “absolute return.” For this service hedge funds have always charged out-sized fees, averaging a fixed 2% managed fee topped with 20% of the profits each year. This fee structure along with the flow of investment money into the industry has made the Absolute Return industry the past decade’s best billionaire maker this side of co-founding Facebook.

Fast forward to today and the idea of the average hedge fund losing money when the market sells off is widely accepted. In the spring of 2014, a down month in the markets that doesn’t lead to most funds losing money would be the big surprise.  To make matters worse, the average fund no longer keeps up with the market on the up swings. A simple Bloomberg analysis last year comparing the HFRX Global Hedge Fund Index to the S&P 500 found that in 8 of the past 10 years, owning the S&P beat the average hedge fund. The under-performance and absolute lack of absolute returns is corroborated by this Morgan Stanley chart of the simple correlation between hedge funds that trade stocks and the overall stock market:

moneygame-cotd-020713

An industry invented to have little correlation with the overall stock market now mirrors it almost 90% of the time. Google “hedge fund correlation” and you will find many other sources that verify this problem, and not just for funds that deal in stocks, but for the industry as a whole. To make matters worse, there is the issue of their complicated, costly and often times downright dangerous structure.

The first lesson taught in any basic investment course is the relationship between risk and return. Not only do hedge funds presently offer poor returns, but they continue to (as they always have) come with very high costs, Most analysis focuses on the hefty management and performance fees the funds charge, but as bad as they are, its the hidden costs that really cripple investors and add to the riskiness of their investment.

The average hedge fund is among the most illiquid and non-transparent investments you can find. Since the funds do not disclose their holdings (except to the SEC on certain positions and with a significant lag) you have no idea how your money is deployed. This creates a serious diversification problem, compounded by the fact that many funds tend to over-own the same names. So if its 2013 and a wealthy investor happens to invest in 5 hedge funds while owning some Apple stock in a personal account, its possible his exposure to that one name was far higher than he would want. What’s worse, he is paying 5 other people a fee to increase his risk. Compare that to the average mutual fund that gives you a daily snapshot of what it owns or the average index fund that gives you almost real-time information.

As for liquidity, when it comes to hedge funds, there is really no such thing. The industry standard is that your money is first locked up for an entire year, and then only redeemable on a quarterly or monthly basis, but only in pieces, and only after you submit a redemption request far in advance. Buried within their subscription agreement most funds have some sort of language that grants them the right to suspend redemptions in a liquidity crunch, often indefinitely. In other words, not only is your money locked up during the good times, but its theoretically completely inaccessible during the bad. The average mutual fund gives you daily liquidity, while the average index fund can be liquidated almost instantly.

In any other investment field, lack of transparency and liquidity are viewed as added costs that result in a “haircut” – or reduction of value.  When you add the poor transparency and even worse liquidity of hedge funds to the hefty dollar fees their managers charge, they are among the most expensive investments ever devised, many times pricier than their index or mutual fund cousins. All of that expense for the indignity of making less money in 8 out of the 10 prior years.

If Capitalism existed on Wall Street, and profits and compensation were tied to real performance, most hedge funds would not only not be able to charge their hefty fees, but they simply wouldn’t exist. After all, why would anyone in their right mind pay a larger expense to capture a lower return? And yet assets under management in the hedge fund industry just hit anther all time high.

All of which begs the question: when will Capitalism come to Wall Street?

 

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Fri, 04/25/2014 - 18:21 | 4697441 yrbmegr
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When there is no longer a tax advantage to spending the marginal dollar on capital rather than labor.

Fri, 04/25/2014 - 18:43 | 4697490 clooney_art
clooney_art's picture

We have neo-capitalism. No semblance to the original definition of capitalism, but folks will preach to you that neo-capitalism is the capitalism this country has always stood for.

Use the radio, TV and a bunch of loud mouths to send the propaganda out.

Fri, 04/25/2014 - 19:12 | 4697565 NOTaREALmerican
NOTaREALmerican's picture

Capitalism is just a word.     When you take any of these ISM concepts, and removed all the sociopaths, assholes, manipulators, and worthless people they all work great.     Put reality back into the mix, and - well - here we are,  this is reality.   

The US is just too big for the sociopaths that run the place to have any shared identity with the nation's dumbasses,  so they feast off the dumbasses.  

Just life. 

Fri, 04/25/2014 - 20:21 | 4697748 aVileRat
aVileRat's picture

Big difference between Kapitalism and Mercantalism. One is where state sponsors and is kingmaker in crown corp projects (and defends barrier to entry with soft or hard force). This is what many people around the world see:

Corporates who must lobby or apply for exclusive contracts to operate a project or bribe to secure a cash flow for a government who only allows them to work if that company pays tribute to the "king", replace king with your state railroad comission, tax structure or tribal warlord/libertard wingnut.

Kapitalism is an open source system where if someone has an idea, they can go get some friends/fools/family together, build a prototype and compete against incumbent players. In theory, a company like Facebook should have been a perfect example of how someone found a niche, built the product, and competed to market domination through competitive advantage and promotion. Ie. a feel good story.

In reality: Facebook was one of many corporates who relied upon legal threats to coerce similar projects into submission, corporate contractors to develop code and instead of marketing the product growing via innoviation they were backstopped by very shady MIC venture capital backers plus agreed at some level to turn their platform into a data farm that not only harvests preferences on an entire generation of americans, but makes them addicted to the "clickbait". To compound this perverse alliance between government and the developer, Facebook was not the first. Going back to Oracle was a whole daisychain of developers who pretended to be Henry Ford wunderkids, who in reality were given very specific honeypot projects to both build and enhance the logistical/tracking capabilities of the US.

Not only did they willfully pervert the source code of Kapitalism, they blatently after 1 (2?) tech bubbles, openly and with much arrogance paraded around their MIC contracts, relationships and abuses. All the while loading up on fake ESOP and stock option plans, while creating no true value add to society beyond their fabricated software bubble world.

As such, many American investors since 2001 generally only know about Zuckerberg, Sandberg, Katz, Bezos, and all the other silicon valley pirates. So their perception of what is ambition, and capitalist innovation is now permantly soured to the system. You ask a first year engineer what he can be, and he will admit the highest aspie. (sic) for his life is to be a software engineer, studying new methods to con 7 year olds to click a sidebar. He has no damn idea or could care less about anything beyond piling into the clique, or slaving for stock options. That is how perverse and warped the system is at this time.

If you walked down the street and name dropped Rex or Hamm, or Harrison, 99% of Americans would have no fucking clue who you are speaking about. Let alone what they did. Hell, 80% of Americans have no clue who Henry Ford or who Thomas Edison was. As in a person, who actually invented shit.

So when you say, Capitalism is just a word. Yes, it is just a word "now". But once upon a time, it was a really big idea. It was the whole premise that a metal worker in Yugoslavia or Germany could go tell the Kyrupp's to fuck themselves, take their idea, and build something fantastic in a world, a land, where they would be their own man. And proud of their freedom without fear of idea theft or rent-seeking. Kapitalism before FDR was a method of life where a person had equal opportunity to excel without a lord taking half. That is why we saw 9 mass migration waves to the USA. That was what Capitalism used to mean, to the Bessemers, the Rockefellers, and all those who once believed in North America, and their own ambitions. Somewhere between 1960 and 2014, the USA became a "get a job, get the skills, find an idea and build it" to "your too fat, we're too slow, its too hard, just click this shit". And many realized it's easier to be paid to click than think. And the outsourcing has pretty much stalled out not only the intellectual base of the non-energy sector in the US, but also killed the education ecosystem of the US universities for applied sciences. And by extension, the quality of the US capital markets I suspect went to the lowest common huckster as a result. Proof? When white shoe banks went from financing nobel prize winners on average, to building flippers/retail products for savings stripping (ie: Subprime in 1996 vs. semiconductor/materials science public offerings).

So while your post could easily be a symptom of the current state of capitalism, I do want to point out that you are wrong. It's just more americans (little A) need to recognize their own strengths, and just how shitty the current economy opportunities are: and start building for themselves again vs. working/whoring yourself out for "clickbait".Thats what fight club is about, stop tuning out; start getting angry and doing something.

Or not.

It's friday, and this is tldr.

 

Fri, 04/25/2014 - 20:57 | 4697815 LetThemEatRand
LetThemEatRand's picture

"As such, many American investors since 2001 generally only know about Zuckerberg, Sandberg, Katz, Bezos, and all the other silicon valley pirates."

Pretty simple reason for this.  The guys who build stuff do it now with slave labor in a different country.  They consider workers to be a necessary evil that should be replaced with the hungrier worker overseas.  The internet guys built wealth here at home, not because they wanted to, but that's how it worked out.  Now they are offshoring too.  That's what cut-throat capitalists do.

What is missing from your analysis is that Henry Ford wanted his workers to earn a wage that would allow them to buy a Ford.  That is also what is missing from America as a whole.  Many here dislike me for bringing up her name over and over, but Ayn Rand -- and what she believed in -- is what has destroyed America.   The middle class is toast because it is seen as irrelevant by those who control all of the capital.   John Galt ain't got shit to sell if there's no one who can afford to buy it.  But Johnny already owns everything he could ever need, he shits hundred dollar bills, and now he just wants power.  Rand was a woman who wanted to be Queen.  And like all Royalty, she has legions of followers who want to suck her ass.

Sat, 04/26/2014 - 08:11 | 4698513 BigJim
BigJim's picture

 What is missing from your analysis is that Henry Ford wanted his workers to earn a wage that would allow them to buy a Ford.

Fuck me - will this canard never die? Henry Ford revolutionised automobile manufacturing by introducing the assembly line. He paid his workers more than what was considered the 'going rate' for manual labour because workers hated assembly work so much, they'd typically quit after a single day. He didn't pay them more so they could afford his products - he paid them more because if he hadn't, he would have been out of business.

Furthermore, by doing so, he necessarily raised the cost of his products by the amount that he was paying them, meaning they were less affordable to everyone else. But, because at the time he had no competitors using his production techniques, that hardly mattered: his cars were still more affordable than his competitors', who were still assembling cars the old fashioned way.

To me, this whole 'Henry Ford paid his workers enough to buy his products' canard is a litmus test of basic economics knowledge. You've failed. You clearly need to read Hazlitt's Economics in One Lesson (you can download it free) or Sowell's Basic Economics. Both are an easy read and will mean you won't do the economics equivalent of pissing your pants in public.

As for Rand - presumably, her works' influence is so pernicious that it is, like AnAnonymous' timeless US Citizenism, capable of resounding backwards through time and derailing our great Republic even before they were written.

Every polity gets hijacked by sociopaths. Ours just happened to have the economic system most resembling capitalism when it happened.

Sat, 04/26/2014 - 09:47 | 4698656 Richard Chesler
Richard Chesler's picture

Courtesy of the parasite scumbags that brought you Zerobama.

Fri, 04/25/2014 - 22:01 | 4697953 n8dawg84
n8dawg84's picture

One of your better posts, helping prove the darwinism theory you preach about in your postings.

Sat, 04/26/2014 - 07:23 | 4698473 Truthseeker2
Truthseeker2's picture
All Four Wheels Come Off The Anglo-American Juggernaut

* * *


"The snake of Predatory Capitalism continues to eat itself as it approaches its very own head."

Fri, 04/25/2014 - 20:09 | 4697727 yrbmegr
yrbmegr's picture

I should say, when there is no longer a tax advantage to using the marginal dollar to invest versus hire.

Fri, 04/25/2014 - 18:23 | 4697448 navy62802
navy62802's picture

... when it's too late.

Fri, 04/25/2014 - 18:29 | 4697458 Yen Cross
Yen Cross's picture

   When will capitalism return to Wall Street?  Read Jeckle Island {dik wad}

Fri, 04/25/2014 - 18:39 | 4697478 PubliusTacitus
PubliusTacitus's picture

Wall Street is a construct of historic institutions, and modern regulation.

 

Because financial services are the most regulated industry in the world, behavior of Wall Street participants must be a reflection of those regulations.

 

When will capitalism come to Wall Street?  As soon as regulations are removed, institutions and participants are forced to bear the consequences of their own actions, and government stops picking winners and losers and helping the TBTF institutions get even TBTF-ier.

 

We are currently going in the opposite direction.

Fri, 04/25/2014 - 18:48 | 4697507 LetThemEatRand
LetThemEatRand's picture

You're buying the propaganda.  Wall Street wrote the regulations and owns the regulators.  Wall Street is the government, and they always pick themselves to win.  Take away the middle man, and they still own all of the capital.  The damage is done.  No way does this battleship turn around by going back to some mythical concept of free markets that never existed in the first place.

Sat, 04/26/2014 - 02:40 | 4698300 PubliusTacitus
PubliusTacitus's picture

Bullshit.

 

I'm in the propoganda, and we most definitely do not own that shit.

 

The damage is most definitely done, but it begs the question, what next? 

 

With this crew, you'd better be ready with max force.

 

 

Fri, 04/25/2014 - 18:39 | 4697481 NOTaREALmerican
NOTaREALmerican's picture

When the smart-n-savvy can figure out a way to use it to screw the dumbasses.  If the smart-n-savvy don't need it, why would "it" exist?

Fri, 04/25/2014 - 18:42 | 4697489 Skin666
Skin666's picture

It's coming

Fri, 04/25/2014 - 18:50 | 4697518 Everybodys All ...
Everybodys All American's picture

When will capitalism come to the Fed?

Fri, 04/25/2014 - 18:54 | 4697522 hoist the bs flag
hoist the bs flag's picture

 whatever. we are in the land of rape n money... preadatory capitalism will eventually kill everyone while paving the planet over with scrap metal to look like Cybertron. down vote me now.

 

Sat, 04/26/2014 - 07:55 | 4697525 blindman
blindman's picture

when will we have an honest money system.
when will that happen?
you tell me.

Fri, 04/25/2014 - 19:13 | 4697571 Atomizer
Atomizer's picture

When we can restore long term investments over the HFT theft/speculative casino risk gambling odds. They fucked it up for themselves. I cannot work up any tears for the K Street rat bastards who are about to lose everything.

Fri, 04/25/2014 - 19:40 | 4697636 Youri Carma
Youri Carma's picture

The future of banking may not be on Wall Street http://www.marketwatch.com/story/the-future-of-banking-may-not-be-on-wall-street-2014-04-25

Chase Bank Slams the Door on More Porn Stars http://www.xbiz.com/news/178172

Fri, 04/25/2014 - 19:40 | 4697640 EggSlayer
EggSlayer's picture

Well, I guess if you really honestly think about it, the heart of wall street is banking, and banking probably has the highest amount of economic value out of any industry.

Fri, 04/25/2014 - 23:44 | 4698143 litemine
litemine's picture

FAIL........

Banking is Non-Productive.............Thus giving no economic Value, .........They Take.

We need Rope, and lots of it.

Fri, 04/25/2014 - 20:13 | 4697740 paint it red ca...
paint it red call it hell's picture

Better Question

When will Justice come to Americans?

Sun, 04/27/2014 - 02:48 | 4700554 polo007
polo007's picture

According to Tullett Prebon Group Limited:

http://www.tullettprebon.com/Documents/strategyinsights/TPSI_009_Perfect_Storm_009.pdf

perfect storm

energy, finance and the end of growth

Summary

The economy as we know it is facing a lethal confluence of four critical factors – the fall-out from the biggest debt bubble in history; a disastrous experiment with globalisation; the massaging of data to the point where economic trends are obscured; and, most important of all, the approach of an energy-returns cliff-edge.

Through technology, through culture and through economic and political change, society is more short-term in nature now than at any time in recorded history. Financial market participants can carry out transactions in milliseconds. With 24-hour news coverage, the media focus has shifted inexorably from the analytical to the immediate. The basis of politicians’ calculations has shortened to the point where it can seem that all that matters is the next sound-bite, the next headline and the next snapshot of public opinion. The corporate focus has moved all too often from strategic planning to immediate profitability as represented by the next quarter’s earnings.

This report explains that this acceleration towards ever-greater immediacy has blinded society to a series of fundamental economic trends which, if not anticipated and tackled well in advance, could have devastating effects. The relentless shortening of media, social and political horizons has resulted in the establishment of self-destructive economic patterns which now threaten to undermine economic viability.

We date the acceleration in short-termism to the early 1980s. Since then, there has been a relentless shift to immediate consumption as part of something that has been called a “cult of self-worship”. The pursuit of instant gratification has resulted in the accumulation of debt on an unprecedented scale. The financial crisis, which began in 2008 and has since segued into the deepest and most protracted economic slump for at least eighty years, did not result entirely from a short period of malfeasance by a tiny minority, comforting though this illusion may be. Rather, what began in 2008 was the denouement of a broadly-based process which had lasted for thirty years, and is described here as “the great credit super-cycle”.

The credit super-cycle process is exemplified by the relationship between GDP and aggregate credit market debt in the United States (see fig. 1.1). In 1945, and despite the huge costs involved in winning the Second World War, the aggregate indebtedness of American businesses, individuals and government equated to 159% of GDP. More than three decades later, in 1981, this ratio was little changed, at 168%. In real terms, total debt had increased by 214% since 1945, but the economy had grown by 197%, keeping the debt ratio remarkably static over an extended period which, incidentally, was far from shock-free (since it included two major oil crises).

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