The dumbest simple index will beat the smartest guys on the Street
Insider Monkey provides high-quality evidence-based articles to inform individual investors about the intricacies of investing.The average hedge fund has produced a worse investment performance in the first half of this year than a portfolio consisting of a savings account at your local bank and a random collection of stocks picked by a blindfolded monkey.
Stop me if you’ve heard this one before.
According to the benchmark HFRX Global Hedge Fund Index, tracked by Hedge Fund Research Inc., the average hedge fund has earned its investors just 2.4% so far this year net of fees.
By contrast, the average stock in the MSCI World index of the developed countries’ equity markets is up 7.7%.
Hedge-fund defenders object that it’s not fair to compare funds directly to the stock market, because hedge funds are “managing risk” and so on. You have to compare them to an overall balanced portfolio of stocks, bonds and cash, right?
OK.
A few years back a study conducted on behalf of the endowment of Cambridge University’s Clare College found that, historically, the best risk-managed simple portfolio for a long-term investor had usually been a balance of 80% stocks and 20% cash (or equivalent, such as Treasury bills), rebalanced once a year.
You can play around with simple portfolios but this will do as well as any. It’s about as simple as you can get.
Someone who put 20% of their money in a federally insured bank savings account, and the other 80% in a random collection of stocks from around the world, picked by monkeys, would be up about 6.2% so far this year. (And that’s assuming for the sake of simplicity that you earned 0% interest on the savings. In reality, you could have done slightly better)
In other words, they would still have earned more than twice the returns of the average hedge fund.
Gosh, the money and effort that goes into those hedge funds really paid off, didn’t it?
Makes you glad your golf-club buddy got you an “in” to the P.T. Barnum Proprietary Algorithm Super Alpha Beta Gamma Buy Me An Omega Global Risk-Managed Wowza Fund, doesn’t it?
Just think of all those math Ph.D.s they hired!
Just think of how hard they’re working! Up before dawn, home after midnight, lunch-is-for-wimps, running on their treadmill desks, popping pills for the blood pressure.
Work, work, work.
“Ripping the markets’ face off.”
“Pulling the trigger” on deals.
Yeah, baby! Real men! Real trading! Real bonuses!
Meanwhile, over here, a bunch of monkeys and a bank account.
Oh well.
This is nothing new. Last year, according to Hedge Fund Research Inc., the average genius hedge fund lost 0.6%. Meanwhile stocks picked by monkeys, plus 20% in the bank, gained 2.3%.
The year before, the average hedge fund earned 6.7%. The monkeys and the bank account did three times better, earning 21%.
In 2012 the monkeys and cash beat the hedge funds by nearly four to one, earning 13% compared to 3.5% for the funds.
It shouldn’t really surprise us. It costs a lot of money to run a great hedge fund — in salaries, bonuses, and all the rest. (Just think of the health-insurance costs when the traders have heart attacks) Those costs have to come out of investors’ returns. So even if the hedge funds did as well as the overall market, before fees, investors would lose out on a net basis.
Your typical hedge fund charges around 2% of the assets as a basic fee, plus 20% of any profits. Do the math. If the average investment portfolio earns 6% a year, your hedge fund manager has to earn 9.5% before fees before you even break even.
In other words, the manager has to beat the market by about 60%. Per year. Good luck with that.
This is the point where we should add that these hedge-fund indexes flatter the industry’s performance, because they are weighted heavily towards the funds that survive and report data.
With all this dismal performance, investors are fleeing hedge funds, right?
Sure, why not.
According to a recent report in the Wall Street Journal, investors instead have been piling in.
According to data supplied by Barclays, about $2.5 trillion is invested in these hedge funds worldwide.
Wall Street. The only place on Earth where the lambs lead themselves to slaughter, to the sound of turkeys cheering for Thanksgiving.
To be honest, I never realized how much overhead these guys were charging. I never use them, of course.
The WSJ runs a column (I think once a quarter) called Darts vs Pro’s. They hang the stock quotes on a wall and throw darts. These are their stock picks. They ask the Pro’s to pick what they think will be the best performing stocks for the quarter. The Dart’s most always win.