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Sound Advice: October 18, 2023

Hedge Funds: One Way To Get Clipped

For most investors, publicly traded stocks, bonds, and mutual funds are the most worthwhile choices, but for some folks, especially those who are more affluent, hedge funds may be of greater interest. 

What’s a hedge fund?  It’s a fund that uses less common strategies to increase the potential for profit while reducing risk.

Sounds good?  Perhaps.  But more often than not the main value turns out to be that of a conversational topic at cocktail parties.  Why? Because not everyone qualifies to get a piece of the action.  Those who do must be accredited investors with net worth exceeding $1 million, not including the value of their primary residences, or annual income over $200,000.

Even if you manage to jump over those hurdles, there is little assurance that it will be worth your while.  Quite the contrary.  From January, 1994 to June, 2023, a two-decade span including both bull and bear markets, the Credit Suisse Hedge Fund Index underperformed the Standard & Poor’s 500 Index by more than 2.8 percentage points in average annual return.

No doubt, there have been isolated, short-term instances of hedge funds that had exceptional returns, but the record clearly underscores the reality that they don’t deliver the goods over extended periods.

What makes things even worse are the fees, which are onerous. The typical hedge fund charges an annual fee of 2% of assets.  In addition, the funds also charge a performance fee of 20% of the fund’s profits.

When you put the numbers together, it becomes increasingly difficult to swallow the difference between what you have to pay and what you are likely to get.  That’s even more problematical when you compare these fees with those of the various S&P 500 or total market index funds, which are readily available at a cost of 0.05% of assets or less.

Quite obviously, the only winners here are the sponsors of the hedge funds.  And just as clearly, the investors are the losers.

So when a friend or acquaintance chirps up about the latest hedge fund discovery, feel free to pay no attention.  Better to be boring and order plain vanilla.  The flavor may not be unusual, but it’s likely to be a more enjoyable choice than weirdo flavors such as Booger, Cicada, and Cold Sweat.  Yes, they are all real.  You can look them up.

N. Russell Wayne, CFP

Any questions?  Please contact me at nrwayne@soundasset.com


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