Last Updated Oct 12, 2011 1:40 PM EDT
Over the full period, the hedge fund index not only has underperformed every single equity asset class, but it also has underperformed even virtually riskless one-year Treasury bills (while taking far more risk) and intermediate-term and longer-term Treasury indexes as well.
To be fair, we'll point out that the hedge fund index did outperform the S&P 500 Index and all the other major equity indexes except for U.S. REITs during the first nine months of this year. However, that isn't exactly a fair comparison as there are many hedge funds that aren't fully exposed to market risk (such as merger arbitrage funds, long/short funds, currency and commodity funds, credit arbitrage funds and so on). Thus, a more appropriate way perhaps to look at these funds is to consider at least comparing their returns to diversified portfolio (such as a 60 percent stock /40 percent bond portfolio, diversified across asset equity asset classes). With that in mind, you can compare any particular mix you think is appropriate. This same analysis should be considered when looking at the long-term evidence.
Given the evidence, the only logical explanations I can think of for the continued popularity of hedge funds are that investors are unaware of the data or invest in hedge funds for the same reasons they buy a Rolex or carry a Gucci bag -- they're expressions of status, prestige, exclusivity and sophistication. Letting emotions such as these determine investment decisions is a recipe for transferring assets from your wallet to the purveyors of such products.
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