Speculators and Hedge Funds: How Do Portfolio Managers Make Money?

Demetri Papacostas and Francesco Tonin

The following discussion will explore if there is something special about those people who take risk, and are able to generate a profit from the markets better than most of us. What makes one person an expert? Why should I pay you to manage my money? What does it mean to have a talent for speculating or creating a market edge? We arrive at a rather controversial conclusion.

DO SUCCESSFUL PORTFOLIO MANAGERS HAVE TALENT?

There is a collective mythology around hedge fund performance and the individuals that create wealth. The reason it is more myth than reality is that performance is very difficult to measure consistently across time and circumstance. Very often, great performance is a result of the frothy times the trader is living through.

How does a portfolio manager (PM) make brilliant trading decisions in the first place? Is it instinct or a set of conscious or subconscious rules? On the surface, a PM will receive massive amounts of information and analysis that could not be assimilated by one human being. Even deciding what is relevant often becomes overwhelming. This is much more relevant and overwhelming in FX where information about a currency involves information