Joseph L. Shaefer: If you’re ready to hand over your wallet to a hedge fund, I have three words of advice: “Don’t do it!” I have written frequently about their exorbitant fees, their hundreds of millions spent stuffing cash in politicians’ campaign funds (er, “lobbying”) and, most of all, their failure to provide good value in return.
Now others seem to be joining in sounding this alert. Mark Hulbert, the investment letter cheerleader/critic, in an article this summer, “The Verdict is In: Hedge Funds Aren’t Worth the Money” reaches the same conclusions. He writes, “Hedge funds supposedly pursue complicated strategies that do well whether markets are going up or down.
“Yet the average hedge fund has done no better than the stock market since the October 2007 bull-market high. The Dow Jones Credit Suisse Hedge Fund index, encompassing nearly 8,000 [hedge] funds, produced a 3.3% annualized gain over this period, versus 3.4% for the Wilshire 5000 Total Market index, which reflects all U.S. stocks, including dividends.
“…A fairer comparison might be with all mutual funds and [ETFs], regardless of investment focus. According to Lipper, the average annualized return of all funds it follows was 5% from October 2007 through the end of April- 1.7 percentage points a year higher than the average hedge fund.
“… Since Oct 2007, a portfolio invested 60% in a stock-market index fund and 40% in a bond index fund has beaten the average hedge fund by 1.9 percentage point a year, with no more downside risk or volatility…”
Of course, averages conceal a lot of over- and under-performance at the tails of a normal probability distribution. So you might say, “Well, sure, there are a lot of also-rans out there, but my hedge fund guru is one of those geniuses 5 standard deviations to the right of the mode/median/mean.”
Oh, really? And in a business with virtually no transparency but much gobbledy-gook about quantitative analysis and black boxes, how do you “know” they are a genius? Because of their past performance? Tell that to the investors in Long-Term Capital Management, whose masterminds included founder John Meriwether, former head of bond trading at Salomon Brothers, Directors Myron Scholes and Robert Merton, 1997 Nobel Prize winners in economics, and former Vice Chairman of the Federal Reserve David Mullins Jr. After these and their other MBAs and PhDs had a couple fabulous years, in 1998 they went so spectacularly bust that the Fed, to prevent investor panic, hastily created a bailout plan.
Thousands of investors may have gone broke , but don’t shed a tear for the LTCM principals. After having left Solly under a cloud for trading irregularities, Mr. Meriwether founded LTCM. After losing everything for investors in LTCM, he founded JWM Partners the very next year. Gullible investors lined up and he had $3 billion under management by 2007, when he lost investors 44% and closed the fund. He is now running his third hedge fund, JM Advisors. (Of course, these gentlemen were paid 2-and-20 for every good year and 2-and-zero for every bad year. The investors were left with massive losses and the hedge fund managers were left with 20% of all the profits for all those preceding good – or lucky – years.)
Lest you think Mr. Meriwether is unusual, his was just the first of many massive hedge funds that attracted billions, then lost everything for their investors. Many now do “good works,” as long as there’s a tax deduction in it for them, and are lauded by those who don’t know or care how they made their money.