BAM Intelligence

Hedge Funds Again Miss the Mark

Hedge funds entered 2017 coming off their eighth-straight year of trailing U.S. stocks (as measured by the S&P 500 Index) by significant margins. And for the 10-year period ending 2016, one that included the worst bear market in the post-Depression era, the HFRX Global Hedge Fund Index produced a negative return (-0.6%), underperforming every single major equity and bond asset class.

These results help explain why more hedge funds closed in 2016 than in any year since the 2008 financial crisis, as investors moved their money to larger firms and withdrew assets. Liquidations last year totaled 1,057, and outflows were $70.2 billion.

The Evidence

Unfortunately for hedge fund investors, so far, 2017 has not been much better. Over the first half of the year, the HFRX Global Hedge Fund Index returned just 2.56%. The table below shows the returns in the first six months of 2017 for various equity and fixed-income indexes.

As you can see, the hedge fund index underperformed eight of the 10 major equity asset classes, but outperformed two of the three bond indexes. We can, however, take our analysis a step further and determine how hedge funds performed against a globally diversified portfolio.

An all-equity portfolio allocated 50% internationally and 50% domestically, equally weighted in the indexes within those broad categories, would have returned 9.8%, outperforming the hedge fund index by 7.2 percentage points.

Another comparison we can make is to a typical balanced portfolio of 60% equities and 40% bonds. Using the same weighting methodology as above for the equity allocation, the portfolio would have returned 6.0% using one-year Treasuries, 6.6% using five-year Treasuries and 7.6% using long-term Treasuries. Each of the three would have outperformed the hedge fund index.

Conclusion

With the freedom to move across asset classes that hedge funds often tout as their big advantage, one would think that would have occurred. The problem is that the efficiency of the market, as well as the costs of the effort, turns that supposed advantage into a handicap. Given the evidence, it’s a puzzle that hedge funds are still managing about $3 trillion in assets.

This commentary originally appeared July 10 on ETF.com

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© 2017, The BAM ALLIANCE


Larry Swedroe, Director of Research

Director of Research

Larry Swedroe is director of research for the BAM ALLIANCE.

Previously, Larry was vice chairman of Prudential Home Mortgage. Larry holds an MBA in finance and investment from NYU, and a bachelor’s degree in finance from Baruch College.

To help inform investors about the evidence-based investing approach, he was among the first authors to publish a book that explained evidence-based investing in layman’s terms — The Only Guide to a Winning Investment Strategy You’ll Ever Need. He has authored six more books:

What Wall Street Doesn’t Want You to Know (2001)
Rational Investing in Irrational Times (2002)
The Successful Investor Today (2003)
Wise Investing Made Simple (2007)
Wise Investing Made Simpler (2010)
The Quest for Alpha (2011)

He also co-authored four books: The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006), The Only Guide to Alternative Investments You’ll Ever Need (2008), The Only Guide You’ll Ever Need for the Right Financial Plan (2010) and Investment Mistakes Even Smart Investors Make and How to Avoid Them (2012). Larry also writes blogs for MutualFunds.com and Index Investor Corner on ETF.com.

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