My Sunday Washington Post column is out. This morning, we look at why hedge fund investing is so very overrated.

The print version had the full headline then there were “You can be a hedge fund investor. But why would you?” (The online version is A hedge fund for you and me? The best move is to take a pass).

Here’s an excerpt from the column:

“Given these increased risks (and higher fees), how have hedge funds performed?

By most measures, not well. They have failed to keep up with major averages when markets were up — and they got mangled (like nearly everyone else) during the 2008-09 downturn. It turns out, most hedge funds are not very hedged.

The latest performance data (via the HFRX Global Hedge Fund Index) reveal that hedge funds haven’t fared well at all: They returned a mere 3.5% in 2012, while the S&P 500-stock index gained 16%. Over the past five years, and the hedge fund index lost 13.6%, while the indices added 8.6%. That’s as of the end of 2012; it has only gotten worse in 2013. Most hedge funds have fallen even further behind their benchmarks this year, gaining 5.4% vs. the market’s rally of 15.4%. As a source of comparison, the average mutual fund is up 14.8%.”

Some of the data on fees is pretty astonishing. According to former JPMorgan Chase hedge fund seed investor author of “The Hedge Fund Mirage,” Simon Lack, this fee arrangement is effectively a wealth transfer from investors to managers.

• From 1998 to 2010, hedge fund managers earned $379 billion in fees. Their fund investors reaped only $70 billion in gains.

• Managers kept 84% of investment profits, while investors netted only 16%.

• Fund of funds/ feeders tack on yet another layer of fees, bringing the industry fee total to $440 billion — ~98%

Astonishing. Full article at Washington Post.


You can be a hedge fund investor. But why would you?
Barry Ritholtz
Washington Post, May 26 2013

Category: Apprenticed Investor, Hedge Funds

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

19 Responses to “You Can Be a Hedge Fund Investor. But Why Would You?”

  1. Petey Wheatstraw says:

    “Managers kept 84% of investment profits, while investors netted only 16%.”

    And the sheep get shorn.

    Then again, llamas might be better for purposes of illustration:


    Talk about a haircut . . .

  2. capitalistic says:

    BR, this is another example of bad data interpretation

    “From 1998 to 2010, hedge fund managers earned $379 billion in fees. Their fund investors reaped only $70 billion in gains”. – Obviously. Not all HF’s are profitable and 2007/2008/2009 was a horrible year for volatility-dependent investment strategies.

    “Managers kept 84% of investment profits, while investors netted only 16%.” – What does this mean? If Company X generates $100 in profit, does that mean that HF managers kept $84? Does investment profits mean in a given year, or over the 1998 to 2010 time period?

    • Its worse than that — The 2% comes off the top no matter what — even if you have losses. So the $379B is:

      Profitable funds – UnProfitable funds = net profit

      But its even worse: This is self-reported data. The hedge funds that went out of business don’t report, nor do many of those with bad numbers. A fair guess is that another 3% in profits were “absorbed” by the combination of non-reporting funds and survivorship bias.

  3. InterestedObserver says:

    Pure gambling. You may get a big payout, but regardless of outcome the house does just fine over time.

  4. James Cameron says:

    > Managers kept 84 percent of investment profits, while investors netted only 16 percent.

    The claim above more than piqued my interest because it would seem to defy the “2 and 20″ standard, at least to someone not familiar with the industry. Of course, it’s much more complex than that as it turns out. See:

    Top Five Alpha Stories of 2012

    Simon Lack: No Yachts for the Customers

    and also:

    Why Investors Should Avoid Hedge Funds

    for more.

  5. Al_Czervik says:

    Best characterization of hedge funds that I’ve seen: “It’s a compensation scheme, not an asset class.”

  6. joebolte says:

    For exactly the reasons given in the article, I don’t want to invest in “hedge funds,” but I do want to invest in Renaissance, Bridgewater, or Soros — funds that have a long and consistent track record of beating the market by a lot. Only problem is I can’t because I am far too small, or many of them are closed to outside investment anyway. Barry, would you recommend against buying into these funds if it were possible?

    • To quote the full article:

      “But what about the top-performing funds, such as Jim Simon’s Renaissance Technologies or Ray Dalio’s Bridgewater? Sure, give them a call.”

  7. rd says:

    I Don’t Want to Belong to Any Club That Will Accept Me as a Member – Groucho Marx

    As a small investor, there are only a handful of institutions and financial advisors that generally have my best interests at heart (occasional lapses, but in general they do a good job). I would count Vanguard, Schwab, T Rowe Price, and a handful of others in that list. Most of the rest just want to separate as much money from me as possible.

    When the number of hedge funds exploded to more than the number of listed stocks in the US, you knew that the industry was doomed to mediocrity and that eventually they would be calling on the small investors to fills their coffers. However, there are now many options for the “dumb money” to invest in that will offer good diversification at low cost, that this is one call we should definitely not answer.

  8. Hedge funds were made popular by investing legends like Paul Tudor Jones, Julian Roberson and George Soros. At their time there were only a few hundred funds existing and mostly the talented people were running funds. Nowadays we have more than 9000. It looks like that everyone who want to get rich quickly opens a hedge fund.
    Maybe it works and they can collect fees and bonuses. If it doesn’t work, no problem. The legal setup will protect the fund management company to be liable for any losses and they just walk away.
    We still might have some good funds, but vast majority of them is only hunting for easy money.

  9. murrayv says:

    Barry, how did the best 10% of hedge funds perform? Looking at the whole universe hides the fact that there have been effective hedge funds. Murray

    • If you are looking for Alpha generation, then you really want to see the top 100 hedge funds — about 1% of the total.

      My best guess based on partial data I have seen — its not a full Gaussian distribution analysis, so please consider it only a guess — is the top 10% outperform modestly, lifted in large part by the top 1%.

      Look at the top 2-10% and there is some Alpha, but not much

  10. Lyle says:

    Actually its worse than that, if you read more money than god you find that one hedge fund manager finds a strategy that makes money, but because there is no intellectual property protection on investment strategies if the strategy is successful, a lot of other folks copy it, eliminating the market inefficiency that was originally exploited. Its a perfect example of to many cooks spoiling the soup. The hedge fund idea got so popular that the gains to be made had to be divided so many ways they vanished. Or as in the LTCM case everyone followed the same strategy and all got killed.

  11. Tips from Wall St hedge fund gurus fail to reward faithful

    Advice from the gurus of Wall Street may be rather less valuable than their fans would like to believe. Investors who bought on the basis of top tips from one of New York’s most celebrated hedge fund conferences last year spectacularly failed to beat the market.

    The Ira Sohn Investment conference held at New York’s Lincoln Center brings together the leading lights of the hedge fund community to share market insights as a way of raising money for cancer research.

    But a Financial Times analysis of last year’s tips shows decidedly mixed results. An investor who followed every top idea from the 12 speakers last year would have made 19 per cent, less than the 22 per cent gain available from a passive index fund tracking the US stock market.

    Many of the ideas have proved woefully miscued, including some from the most high-profile managers who will return to the stage on Wednesday: David Einhorn of Greenlight Capital and Bill Ackman of Pershing Square.

  12. Sounds like it’s time to fix the tax code. No reason to reward hedge fund managers with tax breaks; they aren’t adding net value to their customers nor, it would seem, to the economy as a whole.

  13. As mentioned for several months, short covering has been a significant contributor to the equity rally.

    Burnt shorters panic buy as they close their losing short trades which has ramped the market higher and higher. The shorters can be hedgers or speculators but the result is the same ~ the market spiked UP.

    What happens when you stretch the bungee cord too far as a result of substantial short covering ?
    A waterfall collapse will result as there will be less shorters than before and thus less support for the market when longs start panic selling.

    SP500 / DOW / NASDAQ – are dangerously overextended and monthly charts warn of a nasty Wile E Coyote crash. Choppy price action on these indices reveal unstable uptrends that are destined for collapse.

    The Wile E Coyote drop has been delayed but remains a certainty.
    The substantial delay – with much needed corrections prevented due to central bank intervention – ensures the inevitable crash will be worse.

    It’s no brainer.

    DXY [US dollar] monthly chart continues to give bullish warnings and a significant US dollar rally awaits.

    Be careful folks.

  14. [...] funds are performing dismally, according to Barry Ritholtz's eye-opening opinion piece for The Washington Post. After the standard 2% annual fees and 20% they take out of their clients' profits, most hedge [...]