By Guest Blogger Doug Rowat
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Say the words “hedge fund” and an impression is evoked of ultra-sophisticated investment products available only to the most well-heeled investors which virtually always achieve stellar market returns.
Dr. Douglas R. McKay, writing for the Canadian Society of Plastic Surgeons, highlights the hedge fund cliché:
Hedge fund managers are portrayed as the super-elite of the extravagantly wealthy who garner enormous bonuses as a result of wild double- and triple-digit yearly returns.
While Dr. McKay emphasizes that this impression is often inaccurate, the fact that he’s writing on behalf of the Canadian Society of Plastic Surgeons probably does little to dispel the view that hedge funds are only for the “extravagantly wealthy”. Indeed, Dr. McKay goes on to highlight that “some of Canada’s best-known hedge funds carry $3 million minimums to get your foot in the door.”
So, do hedge funds deserve the hype, and are wealthy investors really gaining an advantage over every-day investors by owning them?
The answer is an emphatic no.
The ineffectiveness of hedge funds (and, as a corollary, the effectiveness of low-cost ETFs) was highlighted by—who else—Warren Buffett in 2008 when he made his now-famous US$1 million bet against an asset manager at Protégé Partners arguing that a simple S&P 500 Index fund would outperform a hand-picked selection of hedge funds over the coming decade. Buffett, of course, won the bet with his ETF gaining approximately 126% versus only a 36% gain for the hand-picked hedge funds.
So, who really got rich from the hedge fund investment? The fund managers. Buffett estimated that they took home “60% – gulp! – of all gains.” (Buffett’s winnings from the bet went to charity.)
Buffett’s win and the underperformance of the Protégé picks wasn’t an anomaly. Hedge funds collectively have a shameful long-term record versus the broader US equity market:
HFRX Global Hedge Fund Index (white line) vs the S&P500 (orange): A decade of horrendous underperformance for hedge funds.
Source: Bloomberg
Because of this dismal performance history, the hedge fund industry is badly suffering. 2019 was particularly tough. Bloomberg highlights as much:
The pain kept coming for hedge funds in 2019: if they weren’t being killed off, they were bleeding cash or wringing out dismal returns.
The industry is now on track to record more closures than launches for a fifth straight year, a blow to a market that once minted millionaires at a heady pace. More than 4,000 funds have been liquidated in the past five years…
So, it’s much more likely that the plastic surgeon driving past you in their brand new Porsche got that car not because of the performance of their fancy hedge fund, but simply because they’re charging exorbitant amounts for tummy tucks and face lifts.
Don’t worry though, the manager of that fancy hedge fund driving past the plastic surgeon in an even nicer Porsche? Well, they’re probably out looking for work.
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.