Hedge funds have long been a quagmire for investors according to informed observers. Nevertheless, they somehow attract money with the lure of spectacular returns despite actual poor performance. Hedge funds traverse high-risk and often exotic territories and cannot be readily liquidated. More often than not, they are doomed from the outset by very high management fees and expenses that drag down the net return to investors.
Warren Buffet has called them “manager compensation schemes.” Investors pay for manager expertise, but controlling costs is a better predictor of success than a manager’s track record (which can be misleading), and investors would be better off focusing on controlling costs than looking for star managers (“Rich managers, poor clients,” The Economist).
The very success of the hedge fund industry in attracting money is partly responsible for its disappointing performance. With $2 trillion in hedge funds today there are too many dollars chasing too few market anomalies, which had sometimes produced spectacular returns in years past when there were relatively few hedge fund managers looking for a finite number of opportunities.
With few exceptions, hedge fund returns are, on average, very mediocre and more often spectacularly bad rather than spectacularly good. When hedge funds charge performance fees of 20% of the gains over a certain level plus another 2% management fee, that means the fund has to gain 22% just to break even, which in turn leads to greater risk taking by managers. As The Economist put it: “It is, as a result, easy to think of people who have become billionaires by managing hedge funds; it is far harder to think of any of their clients who have got as rich.”
Hedge funds are problematic enough for institutional investors, who often have as little understanding of what they are buying as the average retail investor. The retailization of hedge funds is a very unfortunate thing. To use Vanguard Funds founder Jack Bogle’s comments about exotic, niche ETFs, they are simply taking advantage of investors’ worst instincts.
Retired, income-oriented investors in search of better yield have been misled into a number of other illiquid quagmires as well ? nontraded REITs and limited partnerships to name a few. Retail investors should avoid alternative investment quagmires, and let that part of the investment landscape return to the anonymity it so richly deserves.
Those who find themselves stuck in alternative investments that have suspended distributions or undergone a significant devaluation should contact an attorney with experience in representing investors in such matters.
Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.