Of course, you should never put too much emphasis on a single year, but 2011 was the third year in a row in which the HFRX index underperformed both equities and bonds, and it's more than 10 years since the HFRX was a real standout.
In 1999, the S&P 500 returned 21 per cent and bonds fell 3 per cent, but hedge funds trounced them both with 27 per cent. The following year, equities headed south while bonds recovered, but hedge funds again came out on top by a handsome margin. Sayonara. HFRX occupied the bottom slot for six of the subsequent 11 years, and never recovered the top slot.
My chart shows what this boils down to in terms of cumulative performance. If your had put one dollar in each of these three sectors every year since 1997 (coinciding with the launch of the HFRX) you would have invested $14 per sector. Your equity pot and your hedge fund pot would both now be worth $17 (in fact, the equity pot fractionally more) and your bond pot would be worth $24. The only hedge fund investments you would feel remotely happy with would have been those made in 2000 or earlier, and even these would still have trailed your bond pot by a mile.
This of course is the average picture across all hedge funds (weighted by their assets - there are about 7,000 hedge funds, but I estimate that about 90 per cent of all hedge fund investments are accounted for by the top 200 funds). Within the average were high profits earned by a few celebrated funds, including John Paulson and George Soros, but there were obviously some pretty dire performances by other funds, including total blowouts such as Peloton and Amaranth.
Nevertheless, the past 10 years have been extremely prosperous for hedge funds. In January 2000, the total value of all hedge funds was about $200bn. But the excellent turn-of-the-century performances resulted in institutional investors throwing money at the sector. Hedge fund assets doubled to $400m within 18 months and motored to $2 trillion by 2007. After redemptions and losses, they currently stand at around $1.6 trillion.
It is hard to imagine that institutional investors are proud of these decisions, especially because hedge funds charge such high fees - I estimate in the region of four to eight times the fees charged by more conventional investment managers. These fee levels undoubtedly account for the poor performance of the hedge fund sector over the past decade as depicted in the chart.
But inside hedge funds the picture has been very different. In 2000, the total fees charged by all funds and funds of funds were about $15bn. Subsequently they rose to $70bn and currently stand at around $35bn.
Much of the data above is from a new book on hedge funds, The Hedge Fund Mirage by Simon Lack. It contains a series of sensational tables analysing how hedge fund profits have been split between hedge fund managers and their clients. However, the tables are difficult to interpret and have been attacked by representatives of the hedge fund industry. That alone makes them worth of a closer look.
