Saturday, 22 December 2012

Hedge funds going nowhere

A picture paints a thousand words:

Up to the crisis of 2008/9 the story was that hedge funds were trailing but they would do better when markets turn south, their bets were "hedged".

That story turned out to be simply not true.

From The Economist:

The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply. A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds (see chart). As a group, the supposed sorcerers of the financial world have returned less than inflation. Gallingly, the profits passed on to their investors are almost certainly lower than the fees creamed off by the managers themselves.

And then: "Justifications for poor performance are as diverse as hedge funds themselves."

But numbers don't lie, performance has been too bad and we don't really need to know the justifications. There can only be one explanation, the 2/20 commission simply doesn't work, it is much too much in favour of the managers, to the detriment of the investors.

[2/20 refers to 2% yearly management fees and 20% of the outperformance]

Interestingly, I know some hedge fund managers who have outperformed their niche markets (for instance Asian small and mediumsize cap stocks) by a wide margin, and I don't think that was luck at all. I am pretty convinced they will continue to do so.

But the bad news is that the returns for the other managers will then even be lower.

Also, there has been a lot of news lately about insider trading cases in the US by hedge fund managers. Apparently, the pressure to perform (justifying the 2/20 commissions) might have been too high for some and they resorted to illegal means.

For those seeking exposure to international stocks and bonds, ETF's might be a good alternative.

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