Most of us remember the Ford Pinto. It went from 0-60mph in less than a minute-- when pushed by a strong tailwind. Getting rear-ended was the last thing anyone wanted because that turtle of a car would burst into flames. To the status conscious world, a hedge fund looks like a Ferrari or a Porsche. What’s under the hood, however, is a gutless, flammable Pinto engine.
This might sound ridiculous. After all, hedge funds are exclusive. They’re designed for the Kardashian jet set. To buy them, investors must be accredited. That means they need a massive income or net worth. But the glitzy rich who buy hedge funds fall for fashion over substance.
The average hedge fund has averaged a compound annual return of less than 1 percent over the past 13 years. But averages aren’t chic. Let’s look at the most popular hedge funds, based on size. They’re large for a reason. Whispers of their greatness likely swept through country clubs like an eligible bachelor’s illicit affair. That’s when the rich poured in money—swelling the funds in size.
Your IRA may not look like a Ferrari or a Porsche. But I’m guessing your Mazdas, Hondas and Fords have left most of the 20 biggest hedge funds gasping in their fumes.
According to Barron’s, the 20 biggest hedge funds have averaged a compound annual return of 6.5 percent during the 3 years ending October 31, 2015. That would have turned a $10,000 investment into $12,079.
Vanguard’s S&P 500 index fund averaged a compound return of 16.4 percent over the same time period. The same $10,000 would have grown to $15,770. Only one of the 20 biggest hedge funds managed to beat the index.
Over the past 5 years, the dollar difference widened. The 20 biggest hedge funds just coughed and sputtered. They averaged a compound return of just 6.8 percent. That would have turned $10,000 into $13,894. The S&P 500, by comparison, roared on every cylinder. It averaged an annual compound return of 14.2 percent. The same $10,000 would have grown to $19,423.
Just one of the 20 biggest hedge funds managed to keep pace.
Ok, I’ll admit, my comparison isn’t fair. Stocks soared over the past five years. Many hedge fund managers invest in different asset classes. So let’s compare these faux Ferraris with something more pedestrian, like Vanguard’s balanced index fund. It averaged a compound annual 5 year return of 9.7 percent. Just three of the 20 biggest hedge funds beat this simple Chevy, which is comprised 60 percent in stocks, 40 percent in bonds.
Why do hedge funds lag? One culprit is fees. Most hedge funds charge a 2 percent management fee. They then take 20 percent of the profits that the fund actually makes. Warren Buffett says it’s a great way for hedge fund managers to get rich fast. But investors pay the price.
Many hedge fund managers also roll the dice. They borrow to invest. When their bets crash and burn, they simply walk away. It’s their passengers who perish. John Lanchester, writing for the New Yorker, reported that most hedge funds disappear after just five years. “Out of an estimated seventy-two hundred hedge funds in existence at the end of 2010, seven hundred and seventy-five failed or closed in 2011, as did eight hundred and seventy-three in 2012, and nine hundred and four in 2013.”
New hedge funds replace them. But the stats are clear. Every three years, one third of hedge funds get rear-ended and explode just like a Pinto.
World’s 20 Biggest Hedge Funds Fall Flat
Total 3 and 5-Year Returns Compared to Benchmarks
|Fund||Total 3 Year Return||Total 5 Year Return|
|Bridgewater Pure Alpha Strat 18% Vol||17.6%||57.3%|
|Millennium International Ltd||41.3%||65.6%|
|Bridgewater Pure Alpha Strat 12% Vol||11.9%||35.6%|
|Winton Futures USD Cls B||27.1%||29.4%|
|Millennium USA LP Fund||42.6%||68.2%|
|Bridgewater All Weather 12% Strategy||2.3%||34.7%|
|Renaissance Inst Diversified Alpha Fund||36.0%||n.a.|
|The Genesis Emerging Mkts Invt Com B||-3.7%||-0.7%|
|Transtrend DTP - Enhanced Risk (USD)||12.4%||6.2%|
|EnTrust Capital Diversified Fund Ltd - C||11.3%||13.9%|
|Winton Futures GBP Cls D||28.2%||30.9%|
|Bay Resource Partners Offshore Fund Ltd||36.5%||42.8%|
|Baring Dyn Asset Alloc I GBP||15.9%||25.6%|
|MKP Opportunity Offshore Ltd||9.6%||25.7%|
|Pinnacle Natural Resources, L.P.||7.9%||17.6%|
|MKP Credit Offshore Ltd||18.9%||34.3%|
|The Genesis Emerging Mkts Invt Com A||-5.5%||-3.7%|
|Aristeia International Limited||7.3%||21.0|
|Babson Capital European Loan B EUR Acc||19.7%||n.a.|
|STS Partners Fund||77.4%||184%|
|Biggest 20 Hedge Fund Average||20.73%||+38.7%|
|Vanguard S&P 500 Index||55.7%||94.4%|
|Vanguard Balanced Index||32%||58%|
|*Returns to October 31, 2015 Sources: Barrons; Morningstar|
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.