Swedroe: Hedge Funds Win With A Draw

October 19, 2015

The third quarter of 2015 brought hedge funds a very small amount of relief from their historically poor performance.

Keep in mind, however, that hedge funds entered January coming off their sixth-straight year of trailing U.S. stocks by significant margins. And for the 10-year period from 2005 through 2014, which includes the worst bear market in the post-Depression era, the HFRX Global Hedge Fund Index returned just 0.7 percent per year, underperforming every single major equity and bond asset class.

Despite their poor performance over the past decade, the latest data show that investors continue to pour money into hedge funds, with total assets under management approaching $3 trillion. What's particularly puzzling is that we don't see this same trend when we look at the fund flows for actively managed mutual funds.

Active Mutual Fund Outflows

While, in aggregate, actively managed funds persistently underperform, investors are taking notice and acting. For example, Morningstar reported that over the one-year period through early December 2014, roughly $92 billion in assets left actively managed U.S. equity funds, while about $160 billion in new inflows went into passively managed U.S. equity products—both traditional index funds and ETFs.

The table below shows the returns of the HFRX Global Hedge Fund Index for the first nine months of 2015, as well as the 10-year period from 2005 through 2014. It also shows the returns of major equity asset classes and of 1-, 5- and 20-year Treasurys.


Year-to-Date Return (%) January-September 2015 Annualized Return (%) 2005-2014
HFRX Global Hedge Fund Index -3.1 0.7
Domestic Indexes
S&P 500 Index -5.3 7.7
MSCI U.S. Small Cap 1750 Index (gross dividends) -7.0 9.0
MSCI U.S. Prime Market Value Index (gross dividends) -7.9 7.2
MSCI U.S. Small Cap Value Index (gross dividends) -8.1 7.9
Dow Jones U.S. Select REIT Index -2.8 8.1
International Indexes
MSCI EAFE Index (net dividends) -5.3 4.4
MSCI EAFE Small Cap Index (net dividends) 2.6 6.0
MSCI EAFE Small Value Index (net dividends) 0.4 6.4
MSCI EAFE Value Index (net dividends) -8.1 3.9
MSCI Emerging Markets Index (net dividends) -15.5 8.4
Fixed Income
Bank of America Merrill Lynch One-Year Treasury Note Index 0.3 2.0
Five-Year U.S. Treasury Notes 4.0 4.5
20-Year U.S. Treasury Bonds 0.1 7.5

60/40 Portfolio Benchmark

Through the first nine months of 2015, the HFRX Global Hedge Fund Index lost 3.1 percent. Note that the HFRX Equity Hedge Index also lost 3.1 percent. Out of the 10 major equity asset classes, the hedge fund index did manage to outperform seven. As is our practice, we will compare that return to the performance of three standard 60 percent stock/40 percent bond portfolios.

For their equity portion, each of the three portfolios we'll consider weights equally the 10 stock indexes in the table above. That means each index represents 6 percent of the total portfolio, and that domestic and international stocks each represent 30 percent of the total portfolio, or half the equity allocation. For their fixed-income portion, our portfolios each use one of the three bond indexes below.

  • Portfolio A uses one-year Treasury notes.
  • Portfolio B uses five-year Treasury notes.
  • Portfolio C uses 20-year Treasury bonds.

Here are the results:


HFRX Global Hedge Fund Index -3.1%
Portfolio A -3.3%
Portfolio B -1.8%
Portfolio C -3.4%

As you can see, the HFRX Global Hedge Fund Index outperformed Portfolio A and Portfolio C by only the slimmest of margins, but underperformed Portfolio B by 1.3 percentage points.

A Draw Is A Win For Hedge Funds

The HFRX Global Hedge Fund Index's average performance against the three portfolios was a slight underperformance of 0.3 percentage points. We'll call that a draw, and a far better performance for hedge funds than in the prior decade.

Hedge funds continue to thrive, with assets under management continuing to set new records. Unfortunately, the evidence makes it clear that investors in hedge funds haven't fared as well as fund vendors or managers.

The result is one of the more puzzling anomalies in finance: the continued growth of an industry that for a long time has delivered miserable results for investors. The only explanation I can offer is that it's the triumph of hype, hope and marketing over wisdom and experience.

We'll check back in on hedge fund performance at the end of the fourth quarter.


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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