Swedroe: Even Stars Knock Hedge Funds

August 27, 2014

 

  • They cause people to pay fees that would be considered highway robbery in even the most wack-a-doo mutual fund.
  • They cause people to buy into “black box”—give me the money and I do what I want with it—investment strategies.
  • They cause people to give their money to creeps they haven’t bothered to check out, the kind of people they wouldn’t trust to run out and buy them a sandwich, much less manage their fortune.
  • They cause people to sign contracts that are so one-sided they would make a credit-card lawyer blanch, including “lock up” clauses that keep their money confined to their funds for as many years as some fund managers should be confined to prison.
  • They cause people to agree, sometimes eagerly, to be treated like slightly retarded schoolchildren and not be given any information about what is being done with their money.
  • They cause people to buy investments products that are functionally equivalent to mutual funds, except they overcharge you and give you the ability to tell your golf buddies that you’ve invested in a hedge fund.

Weiss then concluded with the following:

In return they provide performance that is subpar, inconsistent, not worth all the risk, or all of the above.

I really couldn’t have said it better myself. Of course, not everyone heeds this sage advice. Sometimes not even the smartest guys in the world.

The Nobel Prize, a set of annual international awards bestowed in a number of categories in recognition of cultural and scientific advances, was established through the will of the Swedish philanthropist inventor Alfred Nobel. Each year, the Nobel Foundation decides on the amount of the award given to each prize winner. Because of years of low returns, the foundation was forced to cut the size of its cash prizes in 2012.

The Nobel Prize is one of the most prestigious awards one can receive—which is why it came as a shock when the foundation announced that, in light of the poor performance of its investments, it now plans to increase investments in hedge funds.

What are these people thinking? Are they completely unaware that the returns to hedge funds have been abysmal? With the sole exception of 2008, the HFRX Global Hedge Fund Index underperformed the S&P 500 Index in each of the last 10 calendar years—which brings to mind that adage about even blind squirrels occasionally finding acorns.

Perhaps there was a time when hedge funds were able to deliver alpha—when the industry was much smaller and the investment strategies they typically pursue was less “crowded.” However, the evidence is very clear that time is long gone. While there will always be some hedge funds that will deliver outperformance, there is no evidence that investors are able to identify them ahead of time.

All in all, the decision by the Nobel Foundation can only leave one scratching their head.

Next, we’ll examine the relationship between hedge funds and the market, specifically their impact on returns, liquidity and volatility.


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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