Basically the title. Hedge funds underperform every year as compared to broader ETFs like S&P500 by more than 10%! Given this, who invests in hedge funds? Are they stupid or am I stupid?
[https://www.aei.org/carpe-diem/the-sp-500-index-out-performed-hedge-funds-over-the-last-10-years-and-it-wasnt-even-close/](https://www.aei.org/carpe-diem/the-sp-500-index-out-performed-hedge-funds-over-the-last-10-years-and-it-wasnt-even-close/)
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First response: Take any cherry picked data set such as a the one in the article with a massive grain of salt.
Second: What if they went back to 2000? I don’t know if it would be markedly different but active management needs volatility to outperform broad benchmarks. It creates opportunities instead of why we have seen for the past 15 years. An extended bull market.
The biggest argument between passive and active investing is fees. Cost of trading and managing active funds is difficult to offset.
It’s no surprise HFs outperformed in 2008, a year of high volatility and markets sharply down.
Third: Hedge funds in general are for qualified investors and invest in an array of securities both long and short. So measuring performance vs. S&P isn’t the best comparison.
For everyday investors it doesn’t make sense due to liquidity constraints mostly.
The adage that your better off just owning the S&P over the long term is mostly true across long time spans.
Some people think they’ll get lucky and choose the rare fund that beats the market. Good luck with that.
as someone who spent several years at a big box investment firm (not a hedge fund) engaging with institutional investors regularly, the real answer is institutional investors don’t buy returns, they buy “cover-your-ass-ability.”
there are usually 1-4 people as a group making decisions at the final stages of mandates. hedge funds are attractive to these people because 1) they can talk about their alpha (outperformance relative to market) strategy to their bosses, which justifies their expertise and big paycheck (even if that alpha never seems to materialize) and 2) if things blow up, you can deflect some blame on these guys that were supposed to be so damn smart.
lastly, there is a good amount of cachet for some people in meeting/investing with a HF, and you’d be surprised how much that drives decision making sometimes.
2009-2019 was the biggest bull market in history. The S&P 500 returned close to double digits every year. You could not lose money regardless of where you put it. In these years, simply betting the market as a whole is the best way to make money, since you are skipping the big cuts that fund managers take for themselves.
If you run the same numbers starting 2020, things will look a lot different. When there is market volatility, these investors can use advanced techniques and monetary instruments (shorts, commodities, currencies, crypto, futures trading) to try and cut losses or generate gains. That’s when the value of hedge funds becomes apparent.
There are other things to optimize for than returns. If you’re trying to live off that money and the market tanks something fierce for a year before bouncing back you could heavily erode your capital. in that case you may want to optimize for risk or different types of risk or something in between
I love when I see a question like this in eli5. Have you guys ever talked to a five year old?
Here’s the 5 year old explainer: people who have lots of money get told by people who want their money, that they can make more money by giving it to them.
There’s a whole lot less rational behavior in the world than economists would have you believe there should be.
Remember, that underperform percentage is the AVERAGE.
Some performed very well, profiting 50%+++ /year
It’s literally in the name “hedge”. These funds are used by rich people to hedge their investments in the overall market not to actually outpace the returns in them.
Bonds underperform equities but investors still buy them because there is less risk.
Same thing with hedge funds, which in theory “hedge” your bets so there is less risk involved and investors are willing to accept the lower returns for the lower risk.
On a risk adjusted basis, hedge funds do out perform the s and p 500
Because hedge funds are a different type of asset class compared to stocks…. you wouldn’t ask why people prefer us t bills to stocks, we understand that risk is rewarded in the market… hedge try to make alfa (non market risk) using any instrument that they are allowed by their investment charter while stocks and index make money on beta (market risk)… beta pays better than alfa but is also more risky
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