5 Reasons You Should Avoid Hedge Funds

Last Updated May 6, 2011 8:37 AM EDT

In 1990, there were only about 530 hedge funds managing about $50 billion. By the end of 2009, there were more than 8,000 hedge funds. And despite the retrenchment in 2008, the hedge fund industry now has in excess of $2 trillion dollars under management. Does performance match the hype?

As we've discussed before, much of the alpha claimed by the industry isn't alpha at all, but forms of risk other than beta. Also, hedge funds have exorbitant fees, around 2 percent of assets and 20 percent of profits. If there's any alpha in the gross returns, that alpha is going to the managers and fund sponsors, not investors. And finally, as all of the returns shown are pretax, and because of their high turnover rates hedge funds tend to be highly tax inefficient, the after-tax results would surely be worse. To sum it all up, the evidence suggests that hedge funds really aren't investment vehicles, they are compensation schemes.

However, the returns reported by hedge funds may not be as good as they claim. The following discusses the large biases in the data that you should know.

Photo courtesy of AMagill on Flickr
  • Larry Swedroe On Twitter»

    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.