One of the knocks against passive investing, also known as indexing, isn't just that you give up all hope of ever beating the market, it's that you're guaranteed to underperform the market slightly because of fees, however paltry as they may be.
Okay, fine. But if you're going to go with active management then the people running your money had better deliver the goods. Investors pay much higher fees to active managers for higher performance -- indeed, performance so good that it not only beats the market, but does so by a margin wide enough to recoup those fees you're paying in the first place.
When it comes to paying for performance there is no better example than hedge funds. After all, when you're charging 2 percent of assets under management and taking 20 percent of profits off the top, well, you had better put up the kind of returns Animal Kingdom did in the Kentucky Derby (20-1 odds!) -- or more.
Seeing as that's the case, this latest bit of data from The Economist should put a big fat smile on the face of index investors everywhere. Perhaps the editors of the esteemed publication have been reading CBS MoneyWatch.com. Since global markets bottomed out in March 2009 returns for a passive basket of stocks have blown away returns for hedge-fund investors, the Economist notes, using data from Thomson Reuters:
According to the Hedge Fund Research index, a closely watched performance measure, total returns to investable hedge funds were just 19.6% in the 26 months to May 2nd...Investors in stockmarkets in the developed world fared well in comparison. They enjoyed returns of more than 114% in the period covered.That means you could have parked your cash at the depths of the market crash in an indexed mutual fund or exchange-traded fund tracking the MSCI developed-world index -- for an annual fee of, say, 0.2 percent to 0.3 percent vs. maybe 1 percent to 2 percent or more for an actively managed fund -- and better than doubled your money by now. Meanwhile, hedge-fund folks got barely 20 percent over the same period.
Jeez, even some boring old passive bond funds -- such as indexed mutual funds or ETFs tracking developed-world government bonds -- edged out hedge-fund performance since the market crash, as this chart courtesy of The Economist shows:
Equity index investors have been enjoying higher returns than their hedge-fund counterparts so far in 2011, too. "Equities have risen by 10%, while hedge-fund investors have seen total returns of only 1.4%," the magazine says.
There are plenty of good reasons for avoiding hedge funds, as my colleague Larry Swedroe recently wrote, and this latest news only underscores his points. Why pay for active management when passive indexing can more than pay for itself?