Hedge fund returns: Just as Adam Smith predicted

Felix Salmon points us to a report about hedge fund returns and tells us that they're now getting about the same returns as the general market. With this nice illustration:


Excecllent, Adam Smith is proved right again. For recall what he said about capital seeking returns.

There's a natural rate (or if you prefer, a general rate) of return to capital. Yet sometimes people find a new way of doing things. Might be a new technology, might be a new method of organization, a new strategy, new goods, but something different which offers a higher return upon capital. Those people that follow that new path make excess profits: no, not profits we consider excessive, just profits above that normal or general rate.

Other capitalists, being greedy and lustful for profits, filthy lucre, thus enter this trade that offers excess profits. More capital trying to exploit this opportunity brings down the return to that normal or general level for each unit of capital seeking to do the exploiting which is what we're seeing above. The super-profits of hedge funds in US equities seem to be gone.

We could just leave it there: but we shouldn't, for it's one of the things that drives society forwards. We want places where excess profits can be made to be exploited: profits are only another way of saying value added and the accumulated value added is the wealth of us all, by definition, that's what economic wealth is. It is the hunger for excess profits that leads capitalists to explore the crooks and crannies of technology to find those places where they might make them. And thus it's that hunger which drives forward technology itself to the benefit of us all.

And, as Old Adam told us all those years ago, those excess profits will get competed away and the hunt will be on for the next opportunity.