The business of picking one investment over another is great for the person doing the picking, but often less so for whoever hands over the cash.

It is rarely the clients of mutual fund companies who own the yachts.

Yet the conclusions of “The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True” are still startling, and the author poses a question to the entire hedge fund industry: How can it prosper when customers are treated so badly?

For instance, if all the money that has ever been invested in hedge funds had instead been put into U.S. Treasury bills, the results would have been twice as good, according to Simon Lack, author of the book published by Wiley.


Lack is well placed to start from that observation, and pile on further evidence of the industry’s failure. He spent most of the last decade investing in hedge funds for JPMorgan after the bank realized that the bursting of the dot-com bubble would lead to much more demand for them.

Lack was a “seeder” — providing the bank’s capital and endorsement to funds in exchange for a share in the lucrative fees charged to later investors.

Just how lucrative those fees are is one of the most surprising aspects of this engaging book.

From 1998 to 2010, he calculates, hedge fund managers took the lion’s share of any investment returns over and above those available from government bonds.


The industry captured fully 86% of the returns it earned for its customers, he finds, and he cautions that this is very likely an underestimate. Layer in more fees to fund managers and consultants, and investor profits disappear entirely.

Yet Lack does not blame hedge fund managers for this sorry state of affairs, or the ecosystem of consultants, bankers and brokers set up to guide cash into their arms. After all, a hedge fund manager’s job is to sell his own fund, not the industry.

Rather, he blames the investors, for whom this book is written. Indeed, much of its value to the reader is in the tales that demonstrate the many and varied ways in which hedge funds can be a terrible investment.

Lack describes the early days of an industry in which finding a good manager was a combination of luck, connections and relentless investigation.


At one point, concerned that his private investigator, “Magnum,” is producing information that is a little too good — verbatim quotes from the human resources records of other banks — Lack is forced to check the background checker.

Meanwhile, he says, the industry, with little regulation and no legal definition of what constitutes a hedge fund, is a recipe for fraud, and potential managers he passes over soon pop up in handcuffs elsewhere.

Admittedly, investors’ lopsided relationship with their managers has started to change, as hedge funds morph into solid, big institutions. However, this also leads Lack to his central critique.

In contrast to banks, which seek economies of size and scale, hedge fund managers produce their best performance when they are small.


With very few notable exceptions, a fund’s nimbleness and its ability to trade without notice erode as it becomes larger.

Yet the pension plans now handing money to hedge funds base their decisions on a record earned when the industry was small and very different from a sector that now looks after more than $2 trillion in customer cash.

By eliminating yesterday’s risks, Lack argues, they are also eliminating yesterday’s returns.

Were hedge funds to calculate and display their performance over time weighted by assets, as Lack advocates, this trend would be abundantly clear.


If investors took just one lesson away from Lack’s book, it should be this: A hedge fund can choose how much capital it will invest, so it should be judged by the return it has produced to each dollar of investor capital, not the simple headline average that funds publish.

Insisting on such transparency would be the first true challenge to the industry’s damning mediocrity.

McCrum is a New York-based investment correspondent for the Financial Times of London, in which this review first appeared.