John Authers starts this otherwise disappointingly fluffy Long View video interview with Andrew Lo with these fascinating charts.
The top chart shows that it was getting tougher being a hedgie between 1998 and 2007. Whereas in early years you really could point to extraordinary returns, these were clearly getting harder to generate. Competition and arbitrage wasn't completely ineffective, we presume.
But the bottom chart shows what the hedgies did: they took on more and more leverage. That is, for a given amount of capital they were given to play with, theyborrowed more and more. In 1998, a hedge fund with $100m to gamble would borrow $200m from the bank and gamble with $300m. The same $100m capital in 2007 was translated into a $1bn to gamble with. Returns fell about five-fold and leverage increased about five-fold ... making for a remarkable constancy in the take home $s of the hedgy.
Here is a plausible behavioural hypothesis. A whole lot of no longer so young men congregated on the big financial centers in the late 90s with the attitude of "we're here to dig for gold; the world owes us a pile of cash; now we just need to go about satisficing our modest goal."
