Some of the problems with these exotic funds include:
- They’re expensive – typically taking 2% annual charges and a 20% cut of returns.
- They can be illiquid, locking away your money for years.
- Many fail to deliver the absolute returns they promise.
- You may not understand what you’re investing in, or the risks. (Think Madoff!)
Now we can add a new drawback – poor performance versus ETFs.
It turns out most hedge funds are currently doing worse than the simplest tracker-and-bond portfolio!
Hedge funds hammered
Despite devoting acres of coverage to hedge funds over the years, The Financial Times has finally noticed that the Emperor may have no clothes:
Hedge funds, the most expensive item on the investment menu, have been producing returns almost identical to portfolios from the cheap burger joints of the advisory business, made up of 60 per cent equities and 40 per cent bonds.
No wonder hedge funds are worried. Bankers report increasing concern among these latter-day masters of the universe over how they will pay the fat bonuses their traders demand.
Up until then it was merely tracking the performance of a cheap 0.5% a year ETF portfolio!
Do you feel lucky, punk?
Whenever I write about exotic funds, somebody will come along and tell me I haven’t considered this or that pet strategy of theirs.
Indeed, a hedge fund fan would argue that the FT piece is flawed since it is comparing a simple portfolio with a basket of hedge funds.
This basket will contain absolute return funds, directional funds, macro funds, corporate activists, and all kinds of other strategies. Each would be expected to do better at different times in the economic cycle.
To which I’d say fair enough, but I’d add that the average investor – including me – is extremely unlikely to be able to judge what strategy is best at any given moment, or to move their money around in time.
As a result, he or she will either:
- Hold the wrong hedge funds some of the time (getting average performance at high cost over the full cycle).
- Or else will have to diversify into several funds (and so again get average performance at high cost over the full cycle).
Keep it simple, silly
If you’re an Ivy League endowment manager like David Swensen with massive resources at your disposal and funds beating down your door to get a chunk of your millions, you may just be able to pick the winners.
Some people will be lucky, too. Sod’s Law says you’ll likely meet one of them in a pub, who’ll tell you he’s made his fortune backing the one in a hundred fund that delivered 10,000% returns.
But you can’t invest based on luck, and I think the average investor will lose money in their doomed search for Perfect 10 investments.
If you must have some excitement, trade a few shares in a side portfolio with a small proportion of your wealth, and be your own hedge fund manager.
You probably won’t beat the market, but at least you won’t be helping someone to buy a Ferrari with your hard-earned cash, either!