Hedge Funds Should Do a Better Job of Making Their Case

Hedge funds, once reserved for the very wealthy, are being marketed to a broadening range of investors with a sophisticated sales pitch: Because the funds’ ups and downs don’t coincide with those of stocks and bonds, adding them to a portfolio will help maintain returns while reducing nerve-racking gyrations.

They need to do a much better job of making their case, starting with being more transparent about their performance.

Consider managed futures, a hedge-fund strategy that involves making bets on derivatives contracts tied to the value of items such as wheat or the Japanese yen. As David Evans reports in the November issue of Bloomberg Markets magazine, it’s a corner of the market riddled with hefty fees, specious data on performance and conflicts of interest. Expenses as high as 9 percent of assets often obliterate investor returns. An index used to promote the funds doesn’t include billions in fees and just contains data voluntarily reported by trading advisers. Some funds’ prospectuses explicitly allow managers to benefit at their clients’ expense -- for example, by secretly betting against fund investments.

After advisers, brokers and others take their cuts, the returns on managed futures leave much to be desired, at least in recent years. Evans reports that of 63 funds that have filed audited financial data with the Securities and Exchange Commission, 29 left their investors with losses over the decade from Jan. 1, 2003, to Dec. 31, 2012. Fees, commissions and expenses ate up 89 percent of the 63 funds’ gains.

Meager returns, though, don’t necessarily mean managed futures are worthless as an asset class. If, as their proponents say, their performance is uncorrelated with that of stocks and bonds, it’s possible that they can provide value as part of a larger portfolio. The funds’ gains and losses would tend to offset or mitigate those of the stocks and bonds, resulting in a similar return with less volatility. This would reduce the likelihood that investors would have to sell at a loss when they need their money.

Unfortunately, the performance data that funds provide to investors often aren’t complete and clear enough to verify such claims. This situation is particularly troubling for the less affluent customers that these funds are increasingly seeking as investors.

If fund advisers and brokers want investors to buy their sales pitch, they’ll have to be more forthcoming. They should publish easy-to-understand information on how a generic portfolio with and without their product would have performed over different periods. They should also publish the actual long-term impact of fees on investor gains or losses. Failing that, if too many investors end up putting their money in funds that generate fees while destroying value, regulators might have to step in and impose the transparency people need to make informed decisions.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.