Swedroe: Hedge Funds Trail Equities

May 05, 2017

Hedge funds entered 2017 coming off their eighth-straight year of trailing U.S. stocks (as measured by the S&P 500 Index) by significant margins. And for the 10-year period ending 2016—one that included the worst bear market in the post-Depression era—the HFRX Global Hedge Fund Index managed to produce a negative return, -0.6%, underperforming every single major equity and bond asset class.

These results explain why more hedge funds closed in 2016 than in any year since the 2008 financial crisis, as investors moved money to larger firms and withdrew assets (Bloomberg, March 2017). Liquidations totaled 1,057 last year and outflows were $70.2 billion.

Unfortunately for hedge fund investors, so far 2017 has not been much better. For the first quarter, the HFRX Global Hedge Fund Index returned just 1.66%. The table below shows the first quarter 2017 returns for various equity and fixed-income indices.

The Results

As you can see, the hedge fund index underperformed eight of the 10 major equity asset classes, but managed to outperform each of the three bond indices. We can, however, take our analysis a step further and determine how hedge funds performed against a globally diversified portfolio.

An all-equity portfolio allocated 50% internationally and 50% domestically—equally weighted in the indices within those broad categories—would have returned 5.4%, outperforming the hedge fund index by 3.7 percentage points.

Another comparison we can make is to a typical balanced portfolio of 60% equities and 40% bonds. Using the same weighting methodology as above for the equity allocation, the portfolio would have returned 3.3% using one-year Treasuries, 3.6% using five-year Treasuries and 3.8% using long-term Treasuries. Each of the three would have outperformed the hedge fund index.

With the freedom to move across asset classes that hedge funds often tout as their big advantage, one would think that would have occurred. The problem is that the efficiency of the market, as well as the costs of the effort, turns that supposed advantage into a handicap. Given the evidence, it’s a puzzle why hedge funds were still managing about $3 trillion in assets at the end of 2016.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

 

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