Ted Seides – A Deep Dive into Hedge Funds - [Invest Like the Best, EP.07]
At a Glance
Ted Seides is the co-founder, former President, and co-Chief Investment Officer of Protégé Partners. He previously studied under David Swensen and worked at the Yale University endowment for five years. This episode offers an in-depth discussion on the current state of the hedge fund industry, fee structures, seed investment models, and manager selection. Seides’ core judgment is that the hedge fund industry is undergoing a structural adjustment, but it is not the end of the road—excellent managers can still create value. However, investors’ return expectations have dropped significantly, allowing the industry to survive amid intensifying competition.
Theme 1: Hedge Fund Fees — "Clearing Price" Rather Than "Exploitation"
Seides argues that hedge fund fees are essentially a clearing price determined by supply and demand, rather than simply being "too high" or "too low."
- Historical Context: In the early 1990s, short-term interest rates were around 5%, and the hedge fund structure was "1 and 20." Yale University's endowment systematically imposed a cost-of-capital hurdle on managers — since going long the S&P and short could only earn about 4%, paying a 20% performance fee was unreasonable. At that time, there was an oversupply of quality hedge fund managers, leaving them with no choice but to accept.
- Current Dilemma: With interest rates now near zero, hedge funds "must pay to play." The media often cites "2 and 20," but the reality is closer to 1.5 and 20. The problem, however, is that if a hedge fund can only generate 6%, this fee structure appears excessive — unless that 6% is entirely alpha.
- Long-Term Trend: Seides predicts that in 10 years, hedge funds will only charge performance fees on "the portion that truly adds value." In equity strategies, this may be based on alpha; in strategies like distressed debt, it is harder to measure. However, the existing $2–3 trillion in assets embedded in high-fee structures will take a long time to shift.
- Inertia Problem: Seides cites an example — a very intelligent head of a multi-family office, while criticizing a distressed fund's 20% performance fee as unreasonable, maintained high-fee relationships with two large distressed funds for 15 years. "That's inertia."
> "The appropriate baseline for hedge fund strategy is a management fee that roughly covers the cost of doing the business... and then an incentive fee that rewards those people for taking risks that can't be achieved cheaply in the marketplace." (In other words: the reasonable benchmark for hedge funds is a management fee that roughly covers operating costs, and a performance fee that rewards managers for taking risks that cannot be cheaply replicated in the market.)
Theme 2: The Logic of Seed Investing – "Getting an Option for Free"
Seides describes seed investing as a model of "getting an option for free" – the performance of seeded funds is roughly comparable to that of non-seeded funds, but seed investing brings additional commercial upside.
- Scale and Competition: Over 14 years, Protégé seeded approximately 40 hedge funds. There are only a handful of true seed investors globally – Blackstone, Reservoir, Protégé, Julian Robertson, Grosvenor, among others. Although the amount of capital is substantial, the number of funds seeking seed capital is vast, making competition intense.
- Economic Structure: Seed investors typically receive 15%–25% of fund revenues as a share in exchange for initial capital (roughly $25 million in the early days, now around $75 million to $150 million). Seed investors pay full fees but obtain a discount through the revenue share.
- Key Finding: Seides compared the returns of Protégé's seeded funds versus its non-seeded funds – "for the most part, the funds that Protégé seeded in my time there had roughly the same returns as the funds that Protégé invested in that weren't seeded." This implies that seed investing effectively provides a free commercial upside option.
- Most Memorable Investment: Protégé was the largest first-day investor in John Paulson's subprime mortgage fund. Seides describes its risk-reward ratio shifting from "4 up for 1 down" to "1,000 up for 1 down." "That actually was a perfect investment... once you do that, you have this tendency that you can go look for it again. And you'll probably never find it again in your career."
Theme 3: Manager Selection — "The Checklist of Successful Traits Applies Equally to More Failures"
Seides emphasizes that hedge funds are a people business, but selection is extremely difficult — because the checklist of successful traits applies equally to more failures.
- Three Dimensions: Evaluating a potential manager requires answering three questions — (1) Is he a talented analyst? (2) Can he become a good portfolio manager? (3) Can he build a business around it?
- Operational Pitfalls: Seides points out that 50% of hedge fund failures are attributed to operational issues, but this is an oversimplification. The reality is: managers shift from full-time investing to having to spend time on operations, hiring, and fundraising, leading to reduced investment time and declining performance, which is then blamed on operations. "Hedge fund operations are the same thing [as going to the dentist]. The investors have no patience... of anything going wrong." (Meaning: Hedge fund operations are like going to the dentist — investors have zero tolerance for any mistakes.)
- Pedigree vs. Performance vs. Strategy: Seides believes that for seed investors, the least useful of the three is "short-term strong performance track record" — because it may simply be mean reversion. Meanwhile, "unique strategies" often have limited capacity and are difficult to scale. Pedigree depends on the source institution — those from SAC have difficulty replicating success, while those from Tiger have a higher success rate. The Yale lineage (Seth Alexander, Paul Valente, Andy Golden, etc.) also demonstrates replicable success.
- Luck and Resilience: Seides particularly stresses that many people between the ages of 32 and 38 have never experienced major setbacks, and true resilience only becomes apparent during failure. "Most don't [continue on that path]. Most, at some point in time, struggle and stumble. And sometimes it's only at those moments in time where you start to see things like resilience and tenacity." (Meaning: Most people will struggle and stumble at some point, and only then can you begin to see traits like resilience and tenacity.)
Theme 4: Industry Outlook — "Harder, But Not Impossible"
Seides offers blunt advice to those looking to start a hedge fund: the odds are much lower than 5–10 years ago, but if the passion is strong enough, it is still worth trying — just adjust expectations.
- Declining odds: The probability of success for a very smart, well-trained individual with a strong pedigree is "much lower than it was 5 or 10 or 15 years ago."
- Rising opportunity cost: Today, someone who can raise $20–50 million earns roughly $300,000–500,000 in management fees, whereas working at an existing hedge fund could yield significantly more. 20–30 years ago, this opportunity cost was virtually nonexistent.
- Path to survival: Seides advises targeting $25–50 million, much like entrepreneurs did 20–30 years ago — "if you got to $25 or $50 million, that could be a great life." (Meaning: managing $25–50 million can provide a very comfortable living.) Grow steadily through compounding rather than chasing overnight riches.
- Advice for allocators: Seides believes that default allocations to hedge funds "probably doesn't make any sense." However, hedge funds offer two things that long-only strategies cannot: (1) risk management — underperforming in rising markets but protecting capital during downturns; (2) capital market innovation — identifying and exploiting structural dislocations in markets (e.g., the subprime mortgage crisis). With current market valuations elevated, abandoning hedge funds may not be a wise move.
Mentioned Positions
| Position |
Analyst View |
Key Data |
| John Paulson Subprime Fund |
Positive case (Protégé’s largest first-day investor) |
Risk-reward ratio shifted from "4 up for 1 down" to "1,000 up for 1 down" |
| SAC Capital |
Negative case (alumni struggle to replicate success) |
Generated "phenomenal returns" for years, but alumni could not come close to replicating |
| Tiger Management |
Positive case (high success rate among alumni) |
Multiple alumni became "uber-successful hedge fund managers" |
| Yale System (Seth Alexander et al.) |
Positive case (replicable training framework) |
Multiple alumni successfully managed other endowments |
Judgments Worth Remembering
1. Seides argues that hedge fund fees are a supply-demand clearing price, not exploitation — In the 1990s, Yale obtained favorable terms through a cost-of-capital threshold; today, with interest rates at zero, hedge funds "must pay to play."
2. Seides proposes that seed investing is "getting a free option" — Protégé's seed funds and non-seed funds delivered roughly similar returns, but seed investing brought additional business upside.
3. Seides points out that "the checklist of traits describing successful managers applies equally to more failures" — Among pedigree, performance, and strategy, short-term track records are the least reliable, as they may simply reflect mean reversion.
4. Seides believes hedge funds offer two things that long-only cannot provide — (1) Risk management (underperforming in up markets while protecting capital in down markets); (2) Capital market innovation (identifying structural dislocations).
5. Seides advises new fund founders to target $25–50 million — Like founders 20–30 years ago, compound growth slowly rather than chasing overnight riches.
6. Seides notes that operational failures are often misinterpreted — 50% of failures are attributed to operational issues, but the real cause is that managers shift from full-time investing to running a business, reducing investment time and leading to performance decline.
7. Seides proposes a "frequent flyer discount" fee structure — Lower fees based on the length of the investor-manager relationship, increasing switching costs, but existing funds find it difficult to implement due to entrenched cost structures.
8. Seides believes the hedge fund industry has enormous inertia — Even the most sophisticated allocators maintain 15-year relationships with high fees, and change takes a long time.