Swedroe: Hedge Funds Grow, Returns Fall

May 09, 2016

Shrinking Alpha

As further evidence on the deteriorating performance of hedge funds, we can look at the results of a study by William Bernstein, author of the mini-book, “Skating Where the Puck Was.”

Bernstein examined the returns of hedge funds, applying a three-factor analysis to the Hedge Fund Research Global Returns series for the period 1998 through 2012. Bernstein found that while hedge funds did produce large alphas in the first third of the period (when AUM was relatively small) as investor assets chased those returns, alpha shrank and then turned negative.

From 1998 through 2002, the hedge funds produced an incredible alpha of 9.0%. However, from 2003 through 2007, their alphas went to -0.7%. And from 2008 through 2012, the alpha became -4.5%.

The table below provides additional evidence on just how poorly hedge funds have performed. It shows the annualized return of the HFRX Global Hedge Fund Index for the last 10 calendar years—2006 through 2015—as well as the returns of the major equity asset classes and returns to various maturities of Treasury securities.

Perhaps even more shocking is that, over this period, the only year that the HFRX Global Hedge Fund Index outperformed the S&P 500 was 2008. Even worse, compared with a balanced portfolio allocated 60% to S&P 500 Index and 40% to the Barclays Government/Credit Bond Index, it underperformed every single year.

That investors continue to pour money into hedge funds, despite their persistently poor returns over the past decade and even longer, is one of finance’s great anomalies. It can only be explained as the triumph of hype, hope and marketing over wisdom, experience and evidence.

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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