Hedge funds entered this year coming off their ninth 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 2017, one that included the worst bear market in the post-Depression era, the HFRX Global Hedge Fund Index produced a negative return (-0.4%), underperforming every single major equity and bond asset class.
The following table shows the returns through the first six months of 2018 for various equity and fixed income indexes. The HFRX Global Hedge Fund Index returned -0.8% over that period.
2018 Return (%)
|HFRX Global Hedge Fund Index||-0.8|
|MSCI US Small Cap 1750 (gross dividends)||6.6|
|MSCI US Prime Market Value (gross dividends)||-2.0|
|MSCI US Small Cap Value (gross dividends)||4.0|
|Dow Jones Select REIT||1.8|
|MSCI EAFE (net dividends||-2.7|
|MSCI EAFE Small Cap (net dividends)||-1.3|
|MSCI EAFE Small Value (net dividends)||-3.9|
|MSCI EAFE Value (net dividends)||-4.6|
|MSCI Emerging Markets (net dividends)||-6.7|
|Merrill Lynch One-Year Treasury Note||0.7|
|Five-Year Treasury Notes||-1.2|
|20-Year Treasury Bonds||-3.0|
As you can see, the hedge fund index underperformed four of the five U.S. equity asset classes, but outperformed all five of the international equity asset classes and two of the three bond indexes. However, we can 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 among the indexes from the table within those broader categories, would have lost 0.6% through the first half of the year, outperforming the hedge fund index by 0.2%age points.
Another comparison we can make is to a typical balanced portfolio of 60% equities and 40% bonds. Using the same weighting methodology as above for the equity allocation, the portfolio would have lost 0.1% using one-year Treasuries (outperforming the hedge fund index by 0.7 percentage points), lost 0.9% using five-year Treasuries (underperforming the hedge fund index by just 0.1 percentage points), and lost 1.5% using long-term Treasuries (underperforming the hedge fund index by 0.7 percentage points).
Given the results, and the wide dispersion of returns between U.S. and international equities, one might think hedge funds would have used their freedom to move across asset classes, which they often tout as their big advantage, to better effect.
The problem is that the efficiency of the market, as well as the cost of the effort, can turn that supposed advantage into a handicap. Given the evidence on hedge funds’ underwhelming results, it’s a puzzle why they are still managing about $3 trillion in assets.
I’ll report back again on hedge fund performance after the third 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.