Swedroe: Even Stars Knock Hedge Funds

August 27, 2014

If you don’t believe Swedroe Snark about hedge funds, perhaps critical comments from other investment industry luminaries will stick.

This blog is the second part of a three-part series this week on problems with hedge funds and private equity—how they’re viewed and how they affect financial markets as a whole. The first part was titled “Nails In The Hedge Fund Coffin."

Investors tend to think of hedge fund managers as the superstars of the financial world. Collectively, it’s estimated they now manage somewhere in the neighborhood of $3 trillion. Unfortunately, their reputation hasn’t translated into the type of returns that live up to all the hype.

As we’ve continued to demonstrate over the years, the hedge fund industry has had a hard time keeping up. In fact, over the last 10 calendar years, 2004-2013, the HFRX Global Hedge Fund Index underperformed every single major domestic and international equity asset class. It even managed to underperform one-year Treasury notes, let alone longer-term Treasurys.

Despite this abysmal performance, marketing hype and hope is triumphing over wisdom and experience. Money continues to pour into hedge funds. It just goes to prove Abraham Lincoln’s belief that you can indeed fool some of the people all the time.

Regular readers of my books and blogs know that one of my favorite hobbies is collecting epigrams with words of wisdom for investors. Earlier this week, we discussed the negative consequences of hedge fund use in pension plans, and I thought I’d continue with the hedge fund theme. The following are some of my favorite thoughts about hedge funds.

The first comes from Cliff Asness, one of the founders of Connecticut-based AQR Capital Management. His firm happens to run hedge funds as well as mutual funds. This is his definition of the industry:

“Hedge funds are investment pools that are relatively unconstrained in what they do. They are relatively unregulated (for now), charge very high fees, will not necessarily give you your money back when you want it, and will generally not tell you what they do. They are supposed to make money all the time, and when they fail at this, their investors redeem and go to someone else who has recently been making money. Every three or four years they deliver a one-in-a-hundred year flood. They are generally run for rich people in Geneva, Switzerland, by rich people in Greenwich, Connecticut.”

The next bit of wisdom comes from David Swensen, chief investment officer of Yale University. He writes in his book, “Unconventional Success: A Fundamental Approach to Personal Investment”:

“In the hedge fund world, superior active management constitutes a rare commodity. Assuming that active managers of hedge funds achieve success levels similar to active managers of traditional marketable securities, investors in hedge funds face dramatically higher levels of prospective failure due to the materially higher levels of prospective failure due to the materially higher levels of fees.”


 

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