SOUND ADVICE: February 3, 2021
Hedge Funds: One way to get clipped
And then there are the hedge funds, which are completely different animals. These are the funds that have been conjured up for wealthier investors and promoted with an expectation that their results will be indifferent to meanderings of the markets frequented by the investing public.
For the privilege of participating in these hallowed vehicles, one must meet specified income and asset levels. Also, one must agree to pay fees that typically range in the area of 2% annually along with additional compensation to the managers of 20% of the profits that may be generated.
That’s a stiff price to pay for dismal performance.
Hedge funds follow numerous strategies, many of which are so arcane that it would not be unreasonable to believe that even the managers themselves have no understanding of what they are doing. For the most part, their approach is to make big bets and hope those bets pay off. As with the more traditional kinds of funds, there are few standouts. Their patterns of performance invariably include a few periods of exceptional gain followed by gut-wrenching downswings.
Over the latest 25 years, the hedge funds, on average, have underperformed the S&P 500 Index by several percentage points or more annually. Why would anyone be naive enough to believe that there could be magic here?
Notwithstanding claims the hedge funds may make about repealing the law of gravity, the potential for increased reward continues to be accompanied by exposure to increased risk. In most cases, the risks taken by these “pros” is far greater than the rewards they are earning for their investors.
There is no free lunch.
Beware of geeks bearing formulas.
N. Russell Wayne, CFP®
Sound Asset Management Inc.
Weston, CT 06883