Hedge Funds - Wall Street's New Dodo?

Jun 20, 2016
2 min read

Once the darling of high net worth investors, hedge funds have dropped the ball in recent years. These risky limited partnerships use leverage, short selling, and derivatives in an attempt to deliver market beating returns to investors privileged enough to meet multi-million dollar minimums. However, a low cost index fund (like, one that I can afford the minimum on) would have been a superior option for investors over the last 5 years.

The Problem(s)

According to Bloomberg, there are 3 issues hedge funds have been up against*.

There isn't enough talent. Evidently, it's even hard for these mega rich funds to find good people.
Too much competition. This, despite a general lack of talent. Ok...
Insane expenses. Investors pay 2% annually, plus they give up 20% of gains. OMG!

There's also the numerous SEC violations and scandals that have rocked the hedge fund landscape since the last recession, like THIS ONE last week.

The Results

For the last several years, a basic investment in a low cost balanced index fund beat the hedge fund index every year**. Total outperformance from the index fund tallied up to 32.8%. Putting that number into perspective, a $500,000 investment into hedge funds (starting in 2011) would've amounted to $576,774 vs. $799,430 in the index. Side note- the index accomplished the feat without exotic portfolio strategies and their high fees.

Returns Through May, 2016

It's normal for most investment strategies to deviate from their benchmarks occasionally. But 5 straight years, by those percentages, managed by Wall Street's smartest? C'mon.

What's An Investor To Do?

Warren Buffett put it succinctly at Berkshire Hathaway's annual meeting last April; "There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities,". Sound Familiar?

My recommendation is to accept the market's returns via low cost index funds. I know I'm a broken record, but it's worth repeating. Avoid the temptation to invest in strategies that are confusing, high cost, and tax inefficient; no matter how shiny the sales pitch.

For more info, be sure to check out the Portfolios page of my company's website. For detail on how we deliver value to investors, browse our Investment Philosophy. Questions? Reach out so we can chat!