5 Cases Against Hedge Funds and Why You Should Care

A hedge fund, by definition, should hedge risks for its investors, right?

Wrong!  In fact, hedge funds increase risks for investors, dramatically, here are some facts:

• From 1995 to 2010, hedge fund managers earned $379 billion in fees, the investors in those funds earned only $70 billion in investment gains.
  
• About 1/3 of the hedge funds are funded through feeder funds or fund of funds, which means another layer of fees that will further increases the hedge fund managers' fees.

Why such dramatic wealth transfer from investors to fund managers?  Thanks to its hefty fees.

Case 1 against hedge funds - hefty fees

• Hedge funds charge "2-20" fees: 2% of asset under management, 20% of investment profit
  
• Mutual funds' average annual fee: 1.44%
  
• Index ETF's annual fee is typically under 0.25%.
  

Such fees create huge wealth, for fund managers only, and are a big drag on performances, which brings us to the Case 2 against hedge funds.

Case 2 against hedge funds - poor performance
The following data are based on the HRFX Global Hedge Fund Index performance:

In 2012:

• Hedge funds return: 3.5%
• S&P 500's: 6% gain 

Over the past fix years

• Hedge fund index: negative 13.6%
• S&P 500 index: added 8.6%.  
  

So far in 2013

• Hedge funds: 5.4%
• Mutual funds: 14.8% in average
  
• S&P 500's: 15.4%
  

Smart investment (investing in a low expense index ETF) clearly beats hedge funds easily!

But why investors still sent billions after billions of hard earned money to hedge funds?

For the very elusive benefits, and some non-financial benefits - a bragging right ("I am a limited partners in so and so hedge fund"), access to the client-only market commentaries (which you know how they fare), and a chance to invest in the next star fund manager's hedge funds, which will bring us the third case against hedge funds.

Case 3 against hedge funds - the unpredictable star performers
People have heard of John Paulson, whose bets against subprime mortgages earned him big fame and billions of dollars.  Of course he capitalized that fame and started many more hedge funds, but his performance since then?  One fund lost 52%, and another one lost 35%.  Ouch!

You certainly wish your money is not in one of those funds, but if you are in, can you get out quickly?

Unfortunately the answer is NO, this brings us the case 4.

Case 4 against hedge funds - poor liquidity
For most hedge funds, there is typically two minimums: a minimum amount to invest (that's why it requires investors to be "accredited") and a minimum length of time to keep the money in the funds (usually minimum 1 year), and there is only a very small window when you can withdraw funds,  

If you are truly a billionaire, you probably don't mind losing a few millions, but if you are an ordinary so called "accredited" investor, why do you want to lock money into a hedge fund with unpredictable performance and hefty fees?  Especially when it comes to case 5.

Case 5 against hedge fund - secrecy, with little regulation
The fact is, regulation on hedge funds are beefing up, but when compared with the typical mutual fund industry, hedge funds' operation is still a black box for investors, this should be worrisome given most hedge funds have no limitation in terms of what they can do - they can own derivatives, trade currency futures, buy credit-default swaps, invest in structured products, liquid assets, etc., you name it.

In summary, hedge funds are really for hedge fund managers.  But if you still want to gamble, and not as an "accredited" investor yet, you are welcome to try your luck at the new casino just opened in town - Goldman Sachs Asses management just announced that it would launch a new mutual fund that will allow mom and pop investors to put their life savings into the gambling table, with access to all the trading strategies employed by hedge funds - a Multi-Manager Alternatives Fund (GMAMX), with minimum $1,000 a bet.

Any takers?

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