A follow-up from an earlier post on the subject of Hedge Funds vs. passive investing approaches such as the Permanent Portfolio:
Just 13 percent of the so-called smartest money on the Street are outperforming the S&P 500, and a fifth of all hedge funds are actually in the red during 2012, according to Goldman Sachs data.
No surprise. Most actively managed funds almost never beat the comparative index funds over time. Hedge funds are even worse. Hedge funds usually have high fees and the managers use all sorts of market timing techniques which never work reliably. Speaking of high fees, these funds are some of the worst in the industry:
Hedge fund investors are paying 2 percent fees up front and 20 percent of profits thereafter to managers delivering poor performance and apparently doing little about it.
Basically, most hedge funds will charge your 2% a year win or lose. If they win by gambling with your money? They get the 2% plus 20% of the profits. If they lose? They still get 2%. Not a bad job if you can get it!
Hedge funds have a ton of mystique around them because they are often sold as exclusive products available only to “sophisticated investors“, professional money managers, endowments, pensions, etc. However most hedge funds remain bad investments for the reasons illustrated above (poor performance and outrageously high fees).
Why are these funds marketed so heavily to those with money? Well I think it’s Sutton’s Law in action. You see, Willie Sutton was a famous bank robber who allegedly was asked why he robbed banks. His response?
“Because that’s where the money is.”
(Ok he probably didn’t actually say it, but it sounds good anyway.)
As it were, hedge funds go where the money is to charge their high fees. Why compete head to head for the relatively meager funds of the commoner rabble, when you can soak up some heavy fees by offering your services to people and institutions with lots of dough?
Admittedly, there are SEC rules involved in how hedge funds are sold and who can buy them. Mainly though these funds rely on a certain elite reputation as part of their marketing. They are sold as The Pirates of Wall Street who operate with advanced knowledge, the best researched techniques, the most educated managers, etc. The entire package is designed to make the investment seem special, but in reality hedge funds are anything but. The only people being pirated are the investors.
Luckily, us unsophisticated investors will just have to stick to outperforming these hedge funds with our boring passively indexed strategies such as the Permanent Portfolio. Pity us!