What are Institutional Hedge Funds?

Unable to understand why people continue to pay fund managers enormous fees to manage money for them poorly, I asked a colleague why they would continue to invest with a fund manager when he had clearly underperformed over 14 years.

The answer was that the was really "institutional". Officially, that means the fund has institutionalized investment and risk processes that a repeatable over a large scale, meaning that the fund would operate smoothly even if the fund manager were no longer involved in the running of the fund, or if the fund were manager large sums of money.

I don't know about you but if the fund were to run smoothly, and if all the operational processes were superior to the other funds out there, the fund should at the very least, outperform the stock market over the long run. If you do your homework you will find the vast majority do not. Many funds will hide behind the excuse of "risk-adjusted quality returns". However, I would take high returns over risk-adjusted returns in the long run, I cannot pay my bills saying, "I owe you $10 but will pay you only $7. My $7 should be worth more to you because it was generated with better risk-adjusted returns". Sadly, most landlords and Wal-Mart do not recognize this odd currency of risk-adjusted returns.

So what are "institutional" hedge funds then? They are like growth stocks--you only know what they are after they have become growth stocks. Similarly, institutional hedge funds are simply funds which have raised a lot of money from pensions, endowments, foundations and other "sticky money". LP investors take comfort in investing with other people like themselves and they often stampede into funds that have already raised money, irrespective of merit.