Investing in Hedge Funds Is Terrible  

A blog about business and economics.
April 22 2013 2:29 PM

Here's Why You Can't Make Money Investing In Hedge Funds

Josh Brown has a great post on the timeless theme of how hegde funds underperform more normal asset classes that I liked largely for this evocative analogy about why you're not going to make any money in hedge funds even though someone certainly will:

Unfortunately, investors have plowed over $2 trillion dollars into the hedge fund complex under the misguided assumption that they'd be able to deliver alpha and absolute returns to juice performance. In actual fact, so-called "alternatives" have done the opposite for the vast majority of their investors. And before you say "But what about what's his name?", bear in mind that the rare few hedge funds that have consistently posted great returns would never in a million years take money from you. And the odds of you identifying an emerging manager from the ground floor who becomes Paul Tudor Jones are about the same as you making out with Kate Upton in an outdoor shower on a Tahitian beach. There are amazing and talented fund managers out there - but even the fund of funds industry has been proven ineffective in terms of being able to sort them out from the rest.
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To understand this a bit more formally, the issue isn't that "nobody" can beat the market it's that if you could beat the market you'd be in a position to charge handsome fees for your trouble. And at any given time, some fraction of the people who appear to be able to beat the market are in fact just going to be people who made some lucky calls. But those people will be able to charge fees too. So in fee-adjusted terms, you get a negative valuation. The fact that a lot of the money available for investment in hedge funds comes from things like pensions where the guy deciding who to invest with isn't even investing his own money only makes the field more open for ripoffs.

This dynamic isn't always bad. Venture capital funds seem to earn bad returns for investors too. That turns out to be a means through which clever fund managers trick rich people into subsidizing software innovators—not the worst thing in the world for society. Still, you don't want your personal money invested in anything that involves high fees. Someone out there may be worth the fee, but you're very unlikely to figure out who.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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