Hedge funds have run out of good ideas

February 25, 2011: 8:30 AM ET

Fund managers make ridiculous sums of money for the most obvious stock pick in history: Apple. Is this the best Wall Street has to offer?

Apple stock

Psst...got a hot stock tip from my hedge fund manager.

Blame for the credit crisis has been doled out liberally. Depending on your particular persuasion, it was all the fault of Wall Street, greedy homeowners, lazy ratings agencies, Chinese currency manipulators, bad regulation, bad regulators, or shady mortgage types. The cohort that hasn't gotten its fair share of it all: the idiotic institutional money managers who stepped up to the plate and bought most of the schlock Wall Street was peddling.

Consider all the sound and fury over Goldman Sachs' now infamous Abacus subprime CDO structure, a designed-to-fail package of residential real estate put together at the behest of hedge fund kingpin John Paulson. Are we really supposed to feel sorry for the German bank IKB, which felt it was deceived by Goldman? What the hell were those people doing buying something called Abacus anyway?

But that's water under the bridge. What's not? That highly paid institutional money managers continue to get paid the big bucks to make decisions of dubious merit. Like, for example, paying hedge fund managers 2-and-20 to buy shares in Apple (AAPL) on their behalf. That's 2% fees and 20% of any profits. On Apple.

Goldman Sachs (GS) researchers track what they call the stocks that "matter most" to hedge funds on an ongoing basis. Shares of Apple have been a growing favorite among the so-called best-and-brightest of Wall Street. The stock is their favorite choice—190 hedge funds were big owners in the third quarter of 2010, and then 195 in the fourth. They love Apple more than they love Google (GOOG), for God's sake.

One of the finer finance commenters on the web, the pseudonymous Tyler Durden, wrote last week that this might present a danger to the market. His point: that the more hedge fund managers pile into the obvious Apple story, the more likely an eventual cratering when Apple one day stumbles. Two years ago, Apple stock stood at $91 a share. Today: $342. This is no minor run-up. Durden is more likely to be proven right than wrong.

But I think he misses the more important point: aren't hedge funds supposed to provide alpha—market beating returns—instead of beta, which one might define as buying the most obvious growth play in existence?

Put more simply: the pension funds of teachers and firemen all over this country have chosen to pay hedge funds their ridiculous fees to make the most obvious investment decision available. And they don't seem to mind at all. According to a recent poll of institutional money managers by Bank of America Merrill Lynch (BAC), a full 55% of them expect to increase their direct allocation to hedge funds over the next 12-24 months. It's a good thing Apple's still climbing. (And by the way, Steve Cohen, you should be ashamed of yourself. Even if they never catch you for insider trading, you should be embarrassed that Apple is one of your best ideas. For this they make you a billionaire?)

Don't get me wrong. I love Apple. I write this on a MacBook while simultaneously watching an episode of  Nip/Tuck over Netflix on my iPad. I bought an Apple II+ in 1980. But that's the point, isn't it? Why is our collective retirement money being spent on the inflated salaries of money managers who can't come up with better ideas than giving their money to overpaid hedge fund managers whose best idea is that Apple is a company on the up and up? Is there no better idea than this?

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About This Author
Duff McDonald
Duff McDonald
Contributing Editor, Fortune

Duff McDonald is a contributing editor at Fortune. He has also written for New York, Vanity Fair, Condé Nast Portfolio, GQ, WIRED, Time, Newsweek, and others. In 2004, he was the recipient of two Canadian National Magazine Awards -- best business story (gold) and best investigative reporting (silver) -- for "Conrad's Fall" in National Post Business. Last Man Standing, his biography of Jamie Dimon, chairman and CEO of JPMorgan Chase, was published by Simon & Schuster in October 2009. He is also the co-author, with Owen Burke, of The CEO, a satire.

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