Swedroe: Mystery Of Hedge Fund Survival

April 17, 2015

The first quarter of this year brought hedge funds little in the way of relief from their historically poor performance. They entered 2015 coming off a sixth-straight year of trailing U.S. stocks by significant margins. And for the 10-year period from 2005 through 2014—which includes the worst bear market in the post-Great Depression era—the HFRX Global Hedge Fund Index returned just 0.7 percent per year, underperforming every single major equity and bond asset class.

 

Despite their poor performance over the past decade, the latest data shows that investors continue to pour money into hedge funds, which now have total assets under management of almost $3 trillion. What’s particularly puzzling is that we don’t see this same trend when we look at the fund flows for actively managed mutual funds.

 

In aggregate, actively managed funds persistently underperform, and investors are taking notice and acting. For example, Morningstar recently reported that over a one-year period through early December 2014, roughly $92 billion in assets departed actively managed U.S equity funds, while approximately $160 billion in new inflows went into passively managed U.S. equity products—both traditional index funds and exchange-traded funds (ETFs).

 

A Performance Comparison
Figure 1 shows the returns of the HFRX Global Hedge Fund Index for the first three months of 2015 as well as the 10-year period from 2005 through 2014. It also shows the returns of major equity asset classes and of one-, five- and 20-year Treasurys.

 

Figure 1: Hedge Fund Vs. Equity Index Performance

 

  Year-to-Date Return (%)
January-March
2015
Annualized Return (%)
2005-2014
HFRX Global Hedge Fund Index 2.1 0.7
     
Domestic Indexes    
S&P 500 Index 1.0 7.7
MSCI US Small Cap 1750 Index (gross dividends) 4.6 9.0
MSCI US Prime Market Value Index (gross dividends) -1.1 7.2
MSCI US Small Cap Value Index (gross dividends) 2.7 7.9
Dow Jones US Select REIT Index 4.7 8.1
     
International Indexes    
MSCI EAFE Index (net dividends) 4.9 4.4
MSCI EAFE Small Cap Index (net dividends) 5.6 6.0
MSCI EAFE Small Value Index (net dividends) 5.3 6.4
MSCI EAFE Value Index (net dividends) 3.9 3.9
MSCI Emerging Markets Index (net dividends) 2.2 8.4
     
Fixed Income    
Bank of America Merrill Lynch 0.1 2.0
One-Year Treasury Note Index    
Five-Year U.S. Treasury Notes 2.3 4.5
20-Year U.S. Treasury Bonds  2.4 7.5

 

 

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