The BCK Volatility Blog

June 2017

THE VALUE OF HEDGE FUNDS

June 22, 2017

Investors are constantly trying to beat the market, and are always searching for new methods to help them outperform baseline indexes like the S&P 500 or the Russell 2000. Since inception, the US stock market has averaged roughly 7% per year (adjusted for inflation). A mere 7% may sound easily attainable to a non-investor; however, the seasoned investor knows that this small number can be difficult to surpass.

One of the most discussed and well-known forms of investment vehicles that aim to beat the market are hedge funds. Hedge funds, without diving into too many inessential details, are actively managed pooled investment vehicles. These funds and their respective managers are often found in the headlines of many newspapers and websites, but why? These fund managers are looked up to as some of the brightest investors on the planet.

They manage only the super wealthy’s money (typically, one must earn over $200,000 per year and have a net worth over $1 million to invest in these funds); thus, hedge funds are given a prestigious label. Since these funds are for the rich and are managed by ‘brilliant’ minds of Wall Street, it is assumed that they would exceed benchmark returns. This is not the case; the HFRI Index (Hedge Fund Research, Inc) shows that over the past five years, hedge funds in the United States have average annualized returns of 4.26% per year.

Over the course of the same period, the S&P 500 has annualized returns of roughly 13%. With only about 1,500 of the nation’s 15,000+ hedge funds that have beat the market, the odds are stacked against individuals who pool their money together in these large hedge funds. Many of these individuals find that they do not receive the profits they were hoping for. Typically, we find that the fund’s managers are the ones reaping the profits.

Hedge funds, generally, charge 2% on the amount invested with the and then take 20% of the profits they earn on their client’s investments. We find this to be the 21st century’s form of highway robbery! Why invest in hedge funds when one can simply purchase ETFs like SPY that track the S&P 500, or invest in diversified mutual funds commonly offered by investment management groups such as Vanguard or Fidelity? These funds offer investors a similar form of passive investing, and are significantly cheaper than hedge funds and typically generate a higher annualized return.

With hedge funds failing to beat, or even meet, market benchmarks year in and year out, we are now seeing investors pull their money out of hedge funds at near record numbers. The HFRI estimates that approximately $70 billion was withdrawn from hedge funds in 2016. This is the largest withdrawal since 2009 when roughly $131 billion was taken out of the nation’s hedge funds. Could this be the beginning of a new era of investing? One in which the individual investors, who favor indexing to hedge funds, begin to outperform and dominate the market place.

So, why do we believe we can continue to beat the benchmarks? A quick glance at our historical returns and our approach to investing provides that answer: we use proven signals and profit in all market environments. In 2008, our strategy returned over 25% while the US stock market was pummeled by the housing crisis. The returns are consistent and dependable. In addition, we disagree with charging clients a % fee on their investments. Instead, we charge a flat monthly subscription fee that is miniscule to the average investor.