Last Updated Sep 29, 2011 9:24 AM EDT
There have been many studies demonstrating that money flows follow performance, meaning that investors put their money into funds and sectors that have performed well recently. It also means investors pull their money from poor performers. This unfortunate behavior has been one of the causes of the well-documented phenomenon of investor returns being well below their very own funds. There appears to be a major exception to this rule: Despite the poor and inconsistent performance of alternative investments, investors continue to pour cash into them.
According to Morningstar, investor flows into alternative investments reached $14.7 billion in 2010, up from $10.8 billion in 2009 and just $3.4 billion in 2008. And the flows as of mid-year show that they're on pace to match 2010's total this year. Clearly this is a big trend.
Given the flows, you would think that the returns have been spectacular, and you would be dead wrong. As you consider the data, keep in mind that this three-year period July 2008 2008 through June 2011 2010 includes the period from July 2008 through February 2009 when the S&P 500 Index lost 41.5 percent, the very period when "alternatives" are supposed to provide risk protection. The figures represent the total return for the three-year period.
* Represented by MSCI indexes
The following represents the total return for international indices for the same period:
- MSCI EAFE Index -- -3.8%
- MSCI EAFE Value Index -- -3.4%
- MSCI EAFE Small Cap Index -- 11.2%
- MSCI Emerging Markets Index -- 14.2%
As I discuss in The Quest for Alpha, the long-term evidence on alternatives such as hedge funds is no better. Thus, the only explanations I can think of for the continued rush by investors to pour money into alternatives are:
- Investors are unaware of the evidence.
- While their performance is awful, the marketing machines of Wall Street are so good that they can overcome even this powerful evidence.
More on MoneyWatch:
9 Bits of Conventional Wisdom You Should Ignore International Investing Myths You Shouldn't Believe How to Properly Name IRA Beneficiaries Passive Management Wins in Emerging Markets International Diversification Still Works, if You're Patient
Three ways I can help you become a wiser investor: