Swedroe: Hedge Funds Flop. Again.

January 23, 2015

This article is the fourth of a four-part series containing 12 lessons that prudent investors could learn from the markets in 2014. The first, second and third articles appeared here, here and here.

Today marks the final installment in my series addressing the lessons that the markets taught us last year about prudent investment strategies. As we noted previously, 2014 provided us with a total of 12.

You may have observed by now that many of these same lessons show up year after year. And many times, the markets provide remedial courses on previously taught lessons. It seems, however, that investors keep failing to learn from them and continue making the same errors. But as I’ve said before, there’s nothing new in investing, only investment history you don’t yet know.

Lesson 10: Hedge Funds Are Not Investment Vehicles, They Are Compensation Schemes

This lesson holds the title with the most repeat performances. After all, the HRFX Global Hedge Fund Index earned -0.06 percent last year. The table below shows the returns for various equity and fixed-income indexes. 

 

Benchmark Index 2014 Return (%)
   
HFRX Global Hedge Fund Index -0.6
   
Domestic Indexes  
S&P 500 13.7
MSCI US Small Cap 1750 (gross dividends) 6.1
MSCI US Prime Market Value (gross dividends) 12.5
MSCI US Small Cap Value (gross dividends) 7.4
Dow Jones Select REIT 32.0
   
International Indexes  
MSCI EAFE (net dividends) -4.9
MSCI EAFE Small Cap (net dividends) -4.9
MSCI EAFE Small Value (net dividends) -5.3
MSCI EAFE Value (net dividends) -5.4
MSCI Emerging Markets (net dividends) -2.2
   
Fixed Income  
Merrill Lynch One-Year Treasury Note 0.2
Five-Year Treasury Notes 3.1
20-Year Treasury Bonds 23.9

 

An all-equity portfolio allocated 50 percent to international stocks and 50 percent to domestic stocks, equally weighted within these broad categories, would have returned 4.9 percent last year. And a 60 percent equity and 40 percent bond portfolio, with the same weights for the equity allocation, would have returned 3.0 percent in 2014 using one-year Treasurys. Alternatively, that portfolio would have returned 4.2 percent using five-year Treasurys and 12.5 percent using long-term Treasurys.

Hedge funds tout their freedom to move across asset classes as one of their big advantages. One would think that “advantage” would actually show up. The problem is that the efficiency of the market, as well as the costs of the effort, turn that supposed advantage into a handicap.

Over the long term, the evidence is even worse. For the 10-year period from 2005-2014, the HFRX Global Hedge Fund Index returned just 0.7 percent per year, underperforming every single equity and bond asset class. The table below shows the returns of the various indexes. 

 

 

 

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