Despite their reputation for their investment prowess, hedge funds haven't exactly set the financial world on fire over the past five years. As a recent Bloomberg article pointed out, hedge funds have underperformed the S&P 500 by 97 percentage points since the end of 2008.
Warren Buffett agrees.
In 2008, The “Oracle of Omaha” made a $1-million bet against the industry with hedge fund Protégé Partners. The terms were straightforward. Protégé Partners picked a group of hedge funds that it expected to outperform an S&P 500 index fund over the course of 10 years.According toFortune, thanks to the huge run-up in the S&P 500 in the last few years, hedge funds are already getting trounced. And barring another market meltdown like 2008, they have little hope of catching up.
There are a couple of reasons for hedge funds' poor showing.
First, if you're focused on managing your downside, it's hard to beat a good old-fashioned bull market. There are times -- and the last five years is one of them -- when being “dumb and long” is the single best strategy.
Second, to talk about an “average” hedge fund is misleading. There are a wide range of arcane hedge-fund strategies, each one looking to slice and dice the financial markets in a different way. Global macro funds bet on movements in interest rate currencies and commodities. Long-short funds buy good stocks and sell bad ones. Activist hedge funds -- the strategy that made Carl Icahn wealthier than George Soros -- generate big gains by pressuring companies to get their financial acts together.
Different strategies yield different results.
A “New” Hedge-Fund Strategy
Hedge funds account for 15% of my firm Global Guru Capital's“Ivy Plus" Investment Program, which tracks the asset allocation of the Harvard University endowment. And although the program has performed as advertised, it has been no thanks to stellar performance by hedge fund index-tracking exchange-traded funds (ETF).
Nicholas Vardy is currently editor of the monthly investment newsletter, The Alpha Investor Letter, which provides longer-term global investments. He also writes two weekly trading services, Triple Digit Trader and Bull Market Alert, which focus on making short-term profits in the hottest markets in the world.