Hedge Funds: Sorting Out Fact and Fiction

A new Showtime series centers on a hedge fund manager who used insider trading to secure big returns and extract even bigger fees. The real-life version isn't so shiny.

It is no secret that the primary character in the new Showtime series “Billions” appears to be based on Steven Cohen of SAC (Stephen A. Cohen) Capital, a hedge fund. With a usual charge of 2% for management both in good and bad years plus 20% of any profit, hedge funds can prosper, especially if they make the right bets. And, therein lies the story of the fictional hedge fund manager in “Billions” and the real life Cohen.

Damian Lewis, the actor, is the fictional hedge fund manager in “Billions.” In episode two of the series he states his fee is 3% for management (both in good and bad years) plus 30% of any profit. This is higher than average, presumably because the fictional character is able to make high returns for clients. Image via Wikimedia/Creative Commons License 3.0

It must be good to be a hedge fund manager who has a winning team that creates wealth hand over fist. Especially, if that wealth can be measured in the billions. However, making all that money doesn’t necessarily come easy. On one hand, it could be due to a lot of tedious analysis. On the other, the work behind it could be less mind-numbing. It could be tips from managers or others who know of upcoming announcements that could change the trajectory of a stock. This knowledge can mean a particular stock position purchased at an opportune time will very likely lead to profits. This is called insider trading.

We know which form of diligence Bobby Axelrod, the hedge fund manager in “Billions,” used. Axelrod, played by the red-haired and fit Damian Lewis from the TV series Homeland, runs a hedge fund company with ethics issues. His traders talk to insiders who give them tips on which they act on and then make money—lots of it. Sadly, Cohen, the real life manager, apparently was at the helm of the same kind of organization. In 2014, SAC Capital pleaded guilty to insider trading. Just this month, Cohen reached a settlement with the SEC under which he will be barred from managing money from outside investors for two years. Cohen has accrued $11 billion of personal wealth so even with the legal woes he isn’t hurting.

Would hedge fund managers — fictional or real-life – be super wealthy without inside information? The evidence suggests probably not. Without illegal sources they would be like every other hedge fund. That picture isn’t so pretty.

According to Christopher Clifford, Adam Aiken, and Jesse Ellis from several different universities, the average excess return of hedge funds was not the 3-5% per year that is usually touted, but close to zero during a five-year study. Their paper is entitled “Out of the dark: Hedge fund reporting biases and commercial databases.”

Not only that, but 10-20% of hedge funds fail each year, which means that if they were included in the statistics above the researchers’ results would be even worse.

So, Showtime’s “Billions” may be mesmerizing and the fictional Axelrod may seem glamorous. But, in reality, most hedge funds aren’t so exceptional, at least according to the Clifford, Aiken, and Ellis paper. And, those that are could be so largely because they are using a low bar of morality. Or maybe they are just lucky, at least for a while.

For More:Excess Returns of Hedge Funds Close to ZeroHow One MD's Illegal Behavior Could Benefit Investors