Might some hedge fund investors soon turn to their
brother-in-law's broker? Or a dirt cheap index fund? According
to a study drawn up by Hedge Fund Research, Inc. for
Alpha, fewer than 11 percent of all hedge funds
managers beat the S&P 500 in the first three quarters of
In 2011 the group lost an average 5 percent while the
indices eked out small gains. On average hedge fund managers
have lagged the S&P 500 since 2009. For the three years
ended September 30, 2012, just 12.5 percent of all hedge funds
outperformed that benchmark.
Hedge funds last trounced the S&P in the dark days of
the financial crisis. In 2008 they lost "only" an average 19
percent, vs. a 37 percent drop for the S&P 500. That year
83.5 percent of all hedge funds beat the market.
That's nothing to sneeze at, of course. But hedge fund
performance numbers in 2008 were boosted by systematic
managers-investors who use computers to latch on to trends in a
wide variety of markets-and macro traders, which are similar to
systematic traders except real humans make the trading
decisions-as well as short bias funds that specialize in
betting on stocks they think will go down in price.
Since then, however, these three groups of funds have fared
The short bias funds have lost money in three of the four
subsequent years amid a global bull market.
The systematic and macro funds have lagged the performance
of the average hedge fund in each of the subsequent four years
and have lost money for each of the two past years, including
Why have hedge funds consistently underperformed the market
for the past four years and rarely beaten the averages in the
For one thing, as hedge funds-or any investment pool-grow
larger in size, they become less nimble. Managers with
single-focus strategies might need to expand to markets in
which they are not as comfortable.
Also, as hedge fund managers become more successful, they
personally own a larger share of fund assets. This often makes
them more conservative, as preservation of capital becomes more
important than swinging for the fences to win a slightly better
In addition, as more managers grow their firms and pull in
more assets, they are claiming a bigger share of profits from
the management fee. For many of these firms, asset gathering
and growth have become more important than they once were.
In fact, last year 11 of the 25 highest earning hedge fund
managers on Alpha's annual rich list qualified for the
ranking largely because of their hefty management fees. As a
group they posted investment gains in the single-digit
Superstar hedge fund managers are a rare breed. The
industry's little secret is that perhaps two dozen hedge funds
managers deserve fat two-and-twenty fees and a commitment for
the long term. That's it.
Ease of entry, lure of potential big paydays and light
regulation have attracted hordes of new managers in recent
years, especially after Wall Street retrenched in the wake of
the financial crisis.
According to HFR, 1,757 hedge funds were open for business
at the end of the third quarter, up about 30 percent from the
end of 2008 and up 60 percent since the end of 2002. Over the
past 10 years just half of all hedge funds beat the S&P
The other half of the funds' sophisticated investors weren't
so sophisticated after all.