Another year of lousy returns for hedge funds

(MoneyWatch) 

Before jumping into how hedge funds fared last year, a story in yesterday's Wall Street Journal caught my eye. The FBI made several arrests of people associated with hedge funds on Wednesday, alleging that the group conspired together by passing insider information among one another. According to investigators, the gains from their activity amounted to $61.8 million.

For me, it served as a reminder of one of the main risks of investing in hedge funds. With their typical compensation structure of 2 percent of assets and 20 percent of profits, hedge-fund managers and associates stand to gain a lot of money when they enjoy excellent returns. Unfortunately, that can cause hedge funds to end up with far more risk than may be appropriate, or worse, to end up leading the professionals handling them to do something illegal in pursuit of profits.

Perhaps most amazing, having a leg up on the competition doesn't seem to help hedge-fund returns beat out comparable indexes. As a group, hedge funds trailed each domestic and bond index in our comparison, though they outperformed each of the international indexes. For the period since 2003 (which is the longest for which we have data), hedge funds have underperformed each major index.

While the HFRX index performed poorly against domestic indexes, it's also important to see how hedge funds fared against diversified portfolios. Using the indexes from the table, an all-stock portfolio (50 percent international/50 percent domestic, equally weighted within those broad categories, rebalanced annually) would have returned -7.0 percent.

The typical allocations of pension plans and many investors is 60 percent stocks and 40 percent bonds. A 60/40 portfolio with those weights (using the all-stock portfolio described above for the stock portion) would have returned -4.0 percent using one-year Treasuries for bonds, -0.4 percent using five-year Treasuries and 7.1 percent using long-term Treasuries. Given the freedom to move across asset classes that hedge funds tout as their big advantage, one would think that "advantage" would show up.

With their high risks and seemingly poor returns, you have to wonder why someone would want to be invested in such vehicles.

[InvestorJunkie]

Does the Hedge Fund index include expenses?

[LarryswedroeCBS]

Yes it does. However, would add it doesn't address another serious issue which is TAXES. Hedge funds are notoriously tax inefficient.
Best wishes
Larry

[Looking West]

Just thought I would pass along this review from the WSJ of a new book called the Hedge Fund Mirage by Simon Lack. The book was authored by a JP Morgan insider and one of the take home messages seems to be that Hedge Funds don't perform as well as we are led to believe. The review was printed in the Jan 24 edition.

http://online.wsj.com/article/SB10001424052970204791104577110650751578814.html?mod=ITP_opinion_0

Cheers,

Looking West

[LarryswedroeCBS]

Thanks for sharing, Have ordered this book
Larry

[LarryswedroeCBS]

maynardkeynes
I don't know the breakdown, but you might be right. Having said that there are huge amounts invested in these vehicles. And I have spoken to about 20 groups of very high net worth people and the majority invest in hedge funds, and continue to do so, despite poor returns.
Best wishes
Larry

[LarryswedroeCBS]

mikfinn
Yes hedge funds are the best method known to transfer assets from the wallets of the country club set to the wallets of the purveyors
Best wishes
Larry

[maynardGkeynes]

Unfortunately, I think the main marks in this con are the pension funds, not the country club set. Many, if not most pension fund managers, particularly those of the public pension funds, are mid-level bureaucrats who can be bought off with a hot dog or a free tee shirt from the hedgies.

[mikifinn]

Since you have to pay so much in fees and interest. These fund grow so the banks get the most financially out of your account.