Building your own hedge fund

(MoneyWatch) As we have noted many times, hedge funds seem to be a poor option for investors. Still, the allure of being part of the hedge fund club seems to be too much for some investors to pass up. Now we're seeing mutual funds replicating hedge fund strategies, enticing all investors to be part of the club, but the early indicators show that their performance is just as poor.

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A few months ago, the Wall Street Journal cited four publicly available mutual funds designed to replicate hedge fund strategies, but with much lower costs. The four funds cited were:

We don't yet have much data, as the funds are fairly new. Still, it's worth taking a look to see how they have performed since inception. In other words, we'll hold them accountable. The table below shows the expense ratios and returns for each of the funds, providing us with 11 individual "fund years." For comparison purposes, I've also included the same information for three Vanguard funds:

You'll note that in not a single case did any of the four funds manage to outperform either VFINX or the balanced portfolio. And in only two of the 11 fund years did any of them manage to outperform VBIIX. The bottom line is that the evidence adds to the body of research that demonstrates that if Wall Street is good at anything, it's transferring assets from investor's accounts to theirs. 

Image courtesy of Flickr user 401(K) 2013

[LarryswedroeCBS]

Ed, while that is the supposed reason, the evidence from academic papers is that in general they tend to have high correlation with stocks.
Also over the long term the evidence isn't bad, it's horrific. Over the last ten years they (hedge funds) have underperformed every major equity asset class and basically all bond asset classes as well.
As to their returns, once you adjust for all those factors the answer would be yes.

Best wishes
Larry

[Looking West]

Larry,

Isn't one of the proposed reasons for owning hedge funds is their non-correlation to the stock market (SP500). The time frame you are examining is essentially the up slope of a "V Shape" recovery. In this type of market I don't think you expect these funds to perform as well as the SP500. Wouldn't it be a little more fair to examine how these funds do over a market cycle or some down years? I think the expectation is that these funds will not have dramatic negative yields or perhaps even make money at a time when the SP500 is crashing. Yes, perhaps you can achieve the same diversification with other assets (bonds?) but that's a topic for another day.

To be honest, my problem with these funds is that for some of them they purport to follow some type of hedge fund index based on publicly available information on individual fund strategies. Two problems, there is no motivation for hedge funds to be transparent in their strategies , so there is not reason to believe that the indexes are an accurate representation of the hedge fund investment world. Second, since all hedge funds are essentially active strategies and therefore a zero sum investment wouldn't the expected return be the market return minus expenses (not taking account for leverage, shorting, or alternate strategies such as currency etc.).

Great column, keep on writing.

Ed