Swedroe: Hedge Funds Fail To Impress In Q1

Hedge funds’ long history of underperformance continues so far in 2016.

Reviewed by: Larry Swedroe
Edited by: Larry Swedroe

Hedge funds entered 2016 coming off their seventh-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 2015—one that included the worst bear market in the post-Depression era—the HFRX Global Hedge Fund Index managed to return just 0.7% per year, underperforming every single major equity and bond asset class.

Unfortunately for hedge fund investors, so far, 2016 has not been kind. As one example, a March 14 article in Bloomberg observed that since July, Russell 3000 Index companies in which hedge funds have the highest ownership percentage had plunged 31%, compared with just a 2.8% decline in the S&P 500 Index. The article also noted that Hedge Fund Research Inc. reported that a nine-month stretch in 2015 saw more hedge funds shut down than any time since 2009.

A Long Losing Streak Continues

The bottom line for hedge funds is that their negative performance streak has continued into an eighth year. The HFRX Global Hedge Fund Index lost 1.9% in the first quarter of 2016, underperforming the S&P 500 Index by 3.3 percentage points.

The following table shows the first-quarter 2016 returns for various equity and fixed-income indexes.

As you can see, the hedge fund index underperformed eight of the 10 major equity asset classes, as well as each of the three bond indexes. 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 indexes within those broad categories, would have returned 1.1%, outperforming the hedge fund index by 3.0 percentage points.

Another comparison we can make is to a typical balanced portfolio of 60% equities/40% bonds. Using the same weighting methodology as above for the equity allocation, the portfolio would have returned 0.8% using one-year Treasurys, 2.0% using five-year Treasurys and 3.8% using long-term Treasurys. Each of the three would have outperformed the hedge fund index.

Market Efficiency, Costs Foil Performance

Given the freedom to move across asset classes that hedge funds often tout as their big advantage, one would think that advantage might have shown up. The problem is that the efficiency of the market, as well as the costs of the effort, turns that supposed advantage into a handicap.

Furthermore, over the long term, the evidence is even worse. For the 10-year period 2006 through 2015, the HFRX Global Hedge Fund Index returned just 0.1% per year and, as mentioned above, underperformed every single equity and bond asset class. The table below shows the returns of the various indexes.

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

Again, we’ll look at the results compared to diversified portfolios. For the 10-year period, an all-equity portfolio allocated 50% internationally and 50% domestically, equally weighted in the indexes within those broad categories, would have returned 7.4% per year. And a 60% equity and 40% bond portfolio with those same weights for the equity allocation would have returned 5.9% per year using one-year Treasurys, 7.1% per year using five-year Treasurys and 8.9% per year using long-term Treasurys. All three dramatically outperformed the hedge fund index.

We’ll report back again at the end of the second 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.

Larry Swedroe is a principal and the director of research for Buckingham Strategic Wealth, an independent member of the BAM Alliance. Previously, he was vice chairman of Prudential Home Mortgage.