I think the OP has hit on a dirty secret that many systematic money managers, even if they _believe_ they have some kind of magic or edge, truly are just taking an occult risk. A simple example is selling option premium. You can trade a system that looks great but runs a small risk of big losses. How about mean reversion trades? Same idea - works well until it doesn't. If you think about it, it has a similar risk/reward profile to selling premium.. However, there is something you can do if you are evaluating hedge funds. Run a regression on the hedge fund's returns with the Fama French factors. If VIX explains much of the returns, you can bet the hedge fund is taking option-like risks.
Great analysis. 75% of fund managers can't beat the S&P. Moreover, >95% lose in bear markets. Those figures suggest managers are doing one (or more) of three things: 1) indexing against the market 2) selling short premium 3) borrow short and lend long (Dollar/Yen/discount window carry trade) This is no-brainer, retard-caliber strategies that work until they don't. Then they lose big. Which suggests nearly the entire industry can be chalked up to marketing magic and leverage. Which is true. The only reliable means to assess competency in fund management is Track Record. The only way to do that is to identify funds that return a ~profit every year, including 2 bear markets. A sufficient look back period should be roughly 12 years. Next, I would invest with those funds. Or, if lacking minimum capital, I would email the managers of those funds and ask them to recommend a reading list. The fact is most fund managers can't trade or invest profitably so they rely on slick marketing and quants to beef up their credibility with investors, who are just as clueless. Blind leading the blind.
ghost naled it, whether you think day to day ,month to month,or annual,there is no way they are taking more than your profits if you respect a max drawdown or for a sca;per ,your daily limit,if that happens.you haven't learned to trade,making money is easy,hanging on to it as in the form of losses ,is on you,that's the hard part,thats trading 101
Which fund do you prefer and why? (1) +100% for the first year and - 50% for the second (2) +15% for the first and +15% for the second To give you a hint, you are totally neglecting something called "risk profile". Actually, there are many people with money looking for (1) despite the drawdown. They got a lot of money. Only poor people hate (1) because of the following: 50% of 10 million is 5 million, still a lot of money. You can buy that luxury house and maybe two sports cars. 50% of 5k is 2.5K, now you can't even buy that old used car. This should be enough to understand why your thinking is wrong. You are thinking like a poor man.
Since most people leave their money to compound, the annual return on (1) is effectively zero, so why the choice?
Do not mix up some fund managers, who are not good traders but very good salesmen and marketers, with genuinely talented traders. There are many traders/fund managers who cannot beat the indices but retain a large client base due to their charisma, credentials etc. There are also the options 'gurus' who are mispricing their insurance and collect the tiny premiums for years before blowing the whole fund in one 'outlier' event that wasn't that unusual. These guys are the gamblers you are talking about. On the other hand, there are many traders who have real skill and a big edge who bet very aggressively- they make very good returns but always run the risk of large drawdowns. Like any other business in life there is always some risk in trading- as someone has already said liquidity can occasionally dry up and leave you screwed if you are a big player. If you want to push the envelope and make truly outsized returns you are going to have to tolerate some very large drawdowns over the course of your career. It's a double edged sword.
Not at all. Take George Soros for instance, he decided to close his aggressive hedge fund in 2000 because the drawdowns were too painful to handle emotionally. He could have made more money by running his money that way(making a few huge selected bets every year) but instead choose an 'endowment' model where he is looking for more modest returns. He choose happiness instead of money, more money wont make much of a difference in his life anyway