Masked Man Fallacy
The election of Donald Trump in November ended up being more conclusive than commentators predicted prior to election night.
One cohort that celebrated that result was the hedge fund industry. A report from Reuters showed some of the largest funds made significant gains in the month on the back of the result. Morgan Stanley show that global hedge funds are up over 10% YTD (as at end of Nov). Discovery Capital, run by Rob Citrone (ex Tiger Management) jumped 14.5% and is up over 46% for the calendar year.
Hedge fund allocation has always been a divisive subject with many eschewing the sector due to poor past experiences (especially since 2008) and others making it a permanent allocation in portfolios.
A great paper on the subject of hedge fund performance is called, ‘Size, Age, and the Performance Life Cycle of Hedge Funds’ and was written by Gao, Haight and Yin in 2018. The researchers concluded that smaller funds tend to perform better than their larger counterparts. Larger funds tend to be well known brand names or high-profile managers, which grab a lot of media attention.
Choosing a manager based on how well known they are is also referred to as the ‘Masked Man Fallacy’. No, nothing to do with Zoro. The misconception occurs when one does not recognise or identity something under one description, it must be different from something they DO recognise under another description.
To simplify:
Premise 1 – I know who Bruce Wayne is.
Premise 2 – I do not know who Batman is.
Conclusion – Bruce Wayne cannot be Batman.
In the context of hedge fund selection:
Premise 1 - I know successful hedge fund managers generate high returns.
Premise 2 – I have never heard of this particular hedge fund manager.
Conclusion – This unheard-of fund manager cannot generate high returns.
If you have convinced yourself to make an allocation to this space, you should think carefully about selection and look to avoid the trap of high profile managers with big AUM. Sometimes small can be best.
What do you think?
