Hedge Fund Performance Proves You’re Better Off Doing Your Own Thing

Credit has to be given where it’s due – they certainly know how to talk a big game. Of course, when it comes to getting results, the reality doesn’t always live up to expectations.

No, we’re not talking about politicians (though the idea certainly applied to them as well). We’re talking about hedge fund operators. They’re some of the most vocal people working on and around Wall Street, always able to grab some media attention when they want it, and most investors are more than willing to lend an ear when they speak. When all is said and done though, as attractive as performance-based compensation may seem, these pros don’t do well enough to earn what they collectively earn.

It’s admittedly an easy time to beat up on the industry. David Einhorn, who heads up Greenlight Capital, booked a 6% loss in February, after booking the same-sized loss in January – his worst January ever. Meanwhile, Carl Icahn only created a 2% return for shareholders in 2017, versus the S&P 500’s 22% gain. Pershing Square’s Bill Ackman recently reported he closed at a long-standing short trade in Herbalife (HLF), locking in a painful loss on what was originally a $1 billion direct bet against the stock, but with the purchase of put options along the way that mostly lost money.

It was a trade most observers would argue Pershing Square should have bailed out of a long time ago. But, like so many new and amateur traders, even the seasoned pros aren’t immune to the usual psychological trappings of trading. In this case, Ackman didn’t want to admit to himself (or anyone else) that he was wrong, so much so that he convinced himself he wasn’t… until it was too late.

But anyone can have a bad month, or a bad year? Sure, it happens. It happens within the hedge fund industry a little too often, however, given their self-proclaimed prowess.

The Barclay Hedge Fund Index is a measure of the average return of all hedge funds in the Barclay database.  It is, almost needless to say, a meaningful collective look at how all the key hedge funds are doing. As it turns out, they’re not doing terribly well.

Last year, the average hedge fund gained 10.3%, versus the market’s 22% gain. In 2016, hedge funds were up 6.1% as a group. The S&P 500 gained 9.5%. In 2015, the broad market was down just a hair under 1.0%. Hedge finds didn’t exactly shine then either, basically breaking even. Hedge funds collectively gain 2.9% in 2014, while the market advanced a little more than 11%.

Underperformance is getting to be a habit. Were it one year or even two, it might be palatable. But, the whole point of the “hedge” in the term hedge fund is to shield against downturns (beating the market in good years is a very close second), but neither is happening often enough, or being done well enough.

But the trick is finding the hot hand at the right time, knowing that not all of the best hedge fund managers are going to lead all the time? Maybe, but even then the evidence isn’t convincing that any of them ever do it consistently. Pershing Square lost 13.5% in 2016, and lost 20.5% in 2015, wiping out 2014’s 40.4% gain. 2017 wasn’t any more impressive, with Ackman’s fund down 20%.  Greenlight Capital only posted a 9.4% gain last year, trailing the market. For 2016, Einhorn’s was up a modest 9.6%, barely topping the S&P 500’s gain for the same year. In 2015, Einhorn’s Greenlight lost 20% of its value. Before Icahn’s fund only gained 2% in 2017, it lost 20% in 2016. In 2015, Icahn was down 18%.

Those are results that would get most fund managers and money managers fired. In those three cases though, each fund’s chief still made hundreds of millions of dollars.

In their defense, the market environment has changed from the time when all three managers produced outstanding fame-making results. That’s not really a defense though. The market environment is always changing. They get paid – and paid very well – to spot those changes and adapt to those changes.

So how bad is it? Donald Steinbrugge, chief executive and founder of Agecroft Partners, a consulting and marketing firm that focuses on hedge funds, recently said “There’s 15,000 hedge funds out there and I think 90 percent of those hedge funds aren’t worth the fees that people pay.”

It all begs the question: How is the hedge fund industry still in existence then?

Part of the answer has already been given. Above, credit was given for the great salesmanship these fund managers dish out, convincing investors that any weakness is just a temporary matter. The other part of the answer is on investors’ shoulders themselves. That is, they’re so interested in big returns that they’ll talk themselves into believing hedge funds are the best bets they can make.

They’re not.

While it may not be the solution everyone wants to hear, traders that are looking to consistently beat the market are arguably better off picking their own stocks, and leveraging their potential returns with the use of options. They’re also better off making fewer but sounder bets, and not overcommitting capital to any one single trade. Perhaps more than anything though, traders looking for superior returns may want to turn off the advice-centric television shows and pay a little less attention to the media-centered chatter on the internet. That’s entertainment, not information.

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