Hedge funds are having just as bad a year as ever, but that doesn't seem to stop people from plowing money into the overpriced and underperforming investment vehicles or some hedge fund cheerleaders from saying, erroneously, that the industry's performance has improved.
Last year, investors pulled $70 billion out of hedge funds, according to industry tracker HFR. That seemed to indicate that those who invested in the funds, after nine years of what can charitably be called lackluster performance, had finally realized their mistake. Not quite. This year, $1.2 billion has flowed back into hedge funds. The Wall Street Journal on Monday attributed the reversal in part to a rebound in performance. That's wishful thinking.
The average hedge fund, according to HFR, was up 5.4 percent this year through August, the latest month for which figures are available. That performance, by investment managers who are often collectively called Wall Street's smart money, is 3.5 percentage points worse than if investors had blindly put 60 percent of their money into a broad stock market index fund and the rest into bonds on Dec. 31, 2016, and then gone on vacation for eight months. Equity-only hedge funds have done better, up 8.3 percent through August, nearly matching the return of the 60/40 mix. But the S&P 500 Index, which was up 11.9 percent through August, or 3.6 percentage points better than equity-only hedge funds, is the right benchmark for that group.
And even those performance numbers may be too generous. The 5.4 percent is an average return for all hedge funds, regardless of size. Larger hedge funds, where most of the money is, have done worse this year. Bill Ackman's $10 billion Pershing Square Holdings fund, for instance, was down nearly 8 percent through August. Hedge fund superstar David Einhorn has struggled as well. Weight performance by size, and hedge fund returns drop another percentage point to 4.4 percent. By that measure, hedge funds are trailing the S&P 500 by 7.5 percentage points in 2017, making this a worse than average year, not better. On average, hedge funds have trailed the S&P 500 by slightly more than 6.5 percentage points since the beginning of 2008. That terrible performance is perhaps why a 5 percent return elicits cheers from hedge fund investors. The bar at this point is very low.
Worse is how hedge fund are achieving their middling performance. According to a report in mid-August from Goldman Sachs, four of the top five stocks held by hedge funds were Facebook Inc., Amazon.com Inc., Alibaba Group Holdings and Google parent Alphabet Inc., the same stocks that everyone from my mother to 10-year boys are snapping up. Other hedge funds, according to the Journal, are benefiting from a bet against retailers. These are not investment ideas that you need to pay 2 and 20 for.
What's truly driving money into hedge funds is not a rebound in performance but a shift in the industry to diversified portfolios and less trading. Recently, a number of large fund have cut their outrageous fees. That's helping, too. These are all things that make hedge funds look as if they will be better investments when consultants run their analysis for big-money pension fund clients. So far it's still just smoke and mirrors.
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