More Evidence Hedge Funds Are an Expensive Way to Trail the S&P 500

Photograph by Spencer Platt/Getty Images

For those who take delight in the so-called “smart money” underperforming the “dumb money,” here are some enjoyable new data points that show hedge funds continue to be an overpriced, middling asset class.

Goldman Sachs’s quarterly report on the industry, which tracks 705 funds with a combined $1.5 trillion of bets on stocks, finds that hedge funds have returned an average of 5 percent in 2013, compared to a 15 percent gain in the Standard & Poor’s 500-stock index. Only 5 percent of the funds beat the S&P, while more than one in eight posted a loss. An added insult is that hedge funds charge their clients huge fees—typically, 2 percent of assets and 20 percent of any gains—for the privilege of investing their money and lagging the market.

The 2013 data is the latest leg of a losing streak that has lasted for years, with hedge funds underperforming the S&P ever since the financial crisis. Investors have stubbornly kept allocating money anyway—Hedge Fund Research said in April that funds saw inflows in 14 of the last 15 quarters (PDF)—but now there is evidence that substandard returns may finally be having an effect. According to eVestment, the $2.69 trillion industry has seen net inflows of just $5.8 billion through the first four months of the year, which it calls the slowest rate of growth to start a year on record. (The firm’s database goes back to the third quarter of 2003.) The figure is also the second-worst total on record, after the start of 2009, when investors pulled out $260 billion.

Investors have moved $10.5 billion out of equity hedge funds this year, eVestment says, and put $31 billion into fixed-income and credit strategies. Credit funds have drawn $108 billion since 2009, Bloomberg News reported on May 7, citing Hedge Fund Research, as new restrictions on proprietary trading at banks have pushed their employees towards less-regulated hedge funds. “There’s a continuous brain drain on Wall Street,” Jason Rosiak, head of portfolio management at $3.75 billion Pacific Asset Management, told Bloomberg News. “Hedge funds are playing in asset classes where they previously hadn’t played.”

Goldman’s report shows that hedge funds betting on stocks to rise have done well, but incorrect short positions—which pay off when a stock falls—cut into returns. Goldman keeps a list of 50 “very important short positions” for hedge funds, and 31 of them actually beat the S&P while only four lost value, as the funds hoped.

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