Another year of hedge funds not earning their keep

As published in the Minneapolis Star Tribune 12/14/2019.

A typical hedge fund requires that any interested buyer first meet the definition of an “accredited investor.” That usually means a person who earns at least $250,000 per year or has a net worth of at least $5 million.

If you have ever thought about investing in a hedge fund, perhaps you considered that threshold unreasonable. These days, it’s something to be thankful for.

The performance of hedge funds has been especially poor in recent years, making it more difficult than ever to justify the cost and restrictions they demand of investors.

According to data compiled by financial analytics company eVestment, hedge funds as a category returned 8.9% in 2017 compared to a 21.8% return for the S&P 500.

Many will argue it’s not appropriate to measure hedge funds directly against equities. Fine. A basket of 50% global equities and 50% bonds gained 14.8% in 2017, still well above the Hedge Fund Aggregate.

Hedge funds, we are often told, reveal their true worth during periods of market weakness and high volatility. Well, the S&P 500 lost 4.4% in 2018, which included an especially sharp decline of almost 20% late in the year. The 50/50 basket of global stocks and bonds fell 4.6% in 2018. Hedge funds, as a category, lost even more (-5.1%).

Year-to-date numbers show a continuation of the same trend.

As of mid-November, the S&P 500 had gained 23%, the 50/50 basket was up 14%, and hedge funds just 7%. Statistically speaking, the evidence is overwhelming: Most hedge funds simply don’t live up to their billing.

As you might expect, their investors have noticed. Through the first three quarters of 2019, hedge funds saw net outflows of $77 billion and have experienced six consecutive quarters of outflows overall.

It’s fair, of course, to expect periods of underperformance with any actively managed strategy. But consistently weak returns three years in a row are tough to swallow, especially when the major equity benchmarks have soared to all-time highs.

This isn’t, by the way, meant as an advertisement for passive index investing. There is value to be found in the right actively managed strategies, and risk management (losing less during down markets) is a vital component in helping most people maximize long-term returns.

But why pay close to 2% per year plus incentive fees for that chance? Not to mention limited access to your money (think: quarterly liquidity), K-1 tax reporting likely to require filing an extension, and a real lack of transparency regarding how the dollars are actually invested. Many private-equity strategies — a “cousin” of hedge funds subject to similar constraints — include capital calls, which contractually obligate you to invest more money into their strategy whenever the manager requests it, regardless of previous performance.

Hedge funds have always been a slice of the investment spectrum tailored to the most affluent. They are marketed, and sometimes desired, for their exclusivity.

“Only those people successful enough to qualify have access,” is a familiar sales pitch, especially among advisers at large wirehouse firms with profit-seeking Alternative Investment departments.

Exclusive is meant to suggest “better.” The catch is that “better” more likely describes the compensation of the salesmen and companies offering these products.

So, what’s the true value to be found among hedge funds?

A modicum of added diversification. Brochures and product descriptions will highlight studies showing a portfolio that includes hedge funds displays slightly less volatility and (perhaps) slightly better returns than a similar portfolio comprised only of stocks, bonds, and cash.

The difference, however, is typically minor and it would be interesting to ask the person handing out those brochures how much data (if any) from the last three years are included in those conclusions.

As in any asset class, there are a handful of exceptions to the rule. Managers who can boast long-term records of outperformance, higher risk-adjusted returns, and legitimately unique investment approaches.

Good luck, however, getting access to the best and brightest of those. Even accredited investors are often shutout from the most attractive hedge funds, who long ago closed their doors to new investors, only accept institutional clients, or require $25 million to start a conversation.

It’s also worth mentioning that many hedge funds are not subject to the same degree of rigorous regulatory oversight most investors expect (and deserve) to protect their money.

So, if your invitation to join the hedge fund investors club got lost in the mail, there’s no need to feel left out. If, on the other hand, your investment portfolio already includes hedge funds, it might be time to ask again about the liquidity schedule.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Recent Posts:

Leading indicators support market strength

/
There is always an argument to be made that the stock market is overvalued. Here's a sampling of the current menu for pessimists: Fed tapering is imminent, Stubbornly high inflation, Earnings growth has peaked, Delta variant prolonging the pandemic, Supply chain disruptions. All of those are legitimate factors when considering economic outlooks, but don't forget the following...

'Follow the Fed' made sense for investors, but what about when the Fed's course is uncertain?

/
"Follow the Fed" has proven to be a relatively simple and successful investment strategy, but keeping up with the latest developments at our nation's central bank isn't as straightforward as it used to be.

Keep Strong Market Returns in Perspective

/
Face-to-face client meetings are a thing again in the Marks Group office. Oftentimes, those start with an exasperated retelling of trying times experienced during the pandemic, after which we usually conclude by saying, "At least the market is up!" The S&P 500 has gained nearly 20% year-to-date and more than doubled since its low-point 18 months ago. As of Aug. 31, the S&P had risen seven months in a row. Fifty-four times this year, it closed at an all-time high. The positive momentum, in other words, has been unrelenting.

Leading indicators support market strength

/
There is always an argument to be made that the stock market is overvalued. Here's a sampling of the current menu for pessimists: Fed tapering is imminent, Stubbornly high inflation, Earnings growth has peaked, Delta variant prolonging the pandemic, Supply chain disruptions. All of those are legitimate factors when considering economic outlooks, but don't forget the following...

'Follow the Fed' made sense for investors, but what about when the Fed's course is uncertain?

/
"Follow the Fed" has proven to be a relatively simple and successful investment strategy, but keeping up with the latest developments at our nation's central bank isn't as straightforward as it used to be.

Keep Strong Market Returns in Perspective

/
Face-to-face client meetings are a thing again in the Marks Group office. Oftentimes, those start with an exasperated retelling of trying times experienced during the pandemic, after which we usually conclude by saying, "At least the market is up!" The S&P 500 has gained nearly 20% year-to-date and more than doubled since its low-point 18 months ago. As of Aug. 31, the S&P had risen seven months in a row. Fifty-four times this year, it closed at an all-time high. The positive momentum, in other words, has been unrelenting.

The LPL registered representatives associated with the website may only discuss securities or transact business with persons who are residents of: AL, AZ, CA, CO, FL, IA, IL, IN, ME, MI, MN, MO, NC, ND, NE, NY, OK, OR, SC, TX, VA, WI.
Barron’s Top Financial Advisors (2010-2021) is based on assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work.
The Forbes Best-In-State Wealth Advisor (2018-2021) and the Forbes America’s Top Wealth Advisors (2017) are based on client retention, industry experience, review of compliance records, firm nominations; and quantitative criteria, including: assets under management and revenue generated for their firms.