Tags: 401k | Index Fund | Investor | Hedge Fund

USA Today: A 401(k) Index Fund Investor Can Beat the Average Hedge Fund Titan

By John Morgan   |   Thursday, 21 Aug 2014 10:20 AM

If grades were given out to hedge funds for how well their investments have done in 2014, most of them would probably get a “C,” according to one expert analysis.

Hedge funds are considered the elite of Wall Street for their buccaneering image and reputation for outsized investment returns. Billionaire investors like Bill Ackman, George Soros and David Tepper all lead hedge funds.

But USA Today reported the average hedge fund has trailed the performance of the Standard & Poor’s 500 Index this year, despite the favor they are shown by their wealthy and institutional investors.

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In other words, lowly individual investors who put their money into an S&P 500 Index fund could probably have beat many hedge fund operators year to date.

USA Today said research firm Prequin, a supplier of data and analysis to the alternative assets industry, estimates hedge funds trailed the S&P 500 in 2014 through the end of July, as well as for the past 12 months.

Prequin said that year-to-date through July, its Hedge Fund All Strategies benchmark posted a gain of 3.47 percent, below the 4.45 percent gain for the S&P 500.

Hedge funds trailed the broad U.S. stock market in the past 12 months ending in July by an even wider margin. The S&P 500 gained 14.5 percent in the past year, outdistancing the Preqin Hedge Fund All Strategies benchmark by more than 5 percentage points.

To make matters worse, hedge funds also extract high fees that the average S&P 500 index fund investors does not pay. The typical hedge fund charges 2 percent on assets under management, and also takes away 20 percent of all fund profits.

By contrast, S&P 500 index funds charge as little as 0.2 percent in fees.

“The investment analysts and money managers that run hedge funds are often referred to as the so-called ‘smart money,’” USA Today said. “But the performance of their funds has not lived up to their reputation as the best of the best.”

The newspaper said that in the past 12 months, not a single one of the 19 major hedge fund strategies analyzed by Preqin have enjoyed better returns than the S&P 500.

Bloomberg reported that many hedge funds tend to sell put and call options against their own portfolios, which can exaggerate returns if the market goes their way, but that may be dangerous if things start to unravel.

Since hedge funds do not have to reveal much about their investments, it is possible they actually be holding poorly performing assets buffered by option strategies.

Bloomberg compared hedge funds to a flood-insurance company that sells way too much insurance for way too little, and whose true value as a firm is therefore negative.

“But suppose all you could see was that it raked in money every year, even if you didn’t understand its business. You might be willing to pay for the stock of that company. But you’d be paying for something intrinsically worthless, and when a flood finally hit, your investment would go to zero.”

Bloomberg cited a highly critical study published in the Journal of Financial Economics,which showed that investors in hedge funds received about the same investment return as if they had held Treasurys between 1980 and 2008, and actually made much less than if they had simply bought stocks.

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