…as hedge funds go from bad to worse.
You may have heard of hedge funds but not be entirely sure how they work. In a nutshell a hedge fund is an investment fund that uses complex strategies, is open only to high net worth individuals, has less regulatory oversight than other types of funds, and charges much higher fees.
Normally the word “hedge” means to take precautions to lower risk. This was the case when these funds were first developed in the late 1940s to early 1950s. But it doesn’t apply to today’s iterations, many of which use risky tactics such as leveraging investments in an attempt to amplify potential gains.
Hedge funds are expensive to participate in with a standard 2% management fee plus a 20% share of any gains. And, just like going to Vegas, sometimes the gains are spectacular.
But over longer time periods hedge funds have struggled with performing consistently and about every ten years enough investors get burned to cause this type of fund to fall out of favor.
The investments in hedge funds are managed by people who are supposed to be some of the smartest on Wall Street. With a 20% commission you can afford to hire genius level strategists.
So you might find it surprising that these funds as a whole have had disappointing returns over the past few years. Through the end of 2019 hedge funds were closing down at the highest rate in five years as their aggressive hands-on strategies were under-performing the broader bull market.
But maybe this was because they were positioning themselves for the market crash of early 2020.
Not so. This year hedge funds as a group are faring worse than last year.
If you gather up the most brilliant people in finance and give them hundreds of billions to invest with fewer restrictions than regular mutual funds, you’d think they could beat the market most of the time.
But the reality is that the movements of the financial markets, whether individual stocks or whole sectors, are simply too random to predict in advance consistently. Someone who could accurately predict the exact values of stocks even ten seconds into the future would be cheap at an 80% commission. Hedge funds are like the mad scientists’ laboratories of finance.
Throughout decades of trial and error, the real research has managed to discover strategies and instruments that have proved useful to the average investor.
And they’re also a demonstration of why the most probable strategy for long-term success in investing lies in a diversified portfolio that takes into account the inherent unpredictability of the market rather than trying to outsmart it.
I know it sounds repetitive, but it’s always worth repeating: the market doesn’t stay in decline and always bounces back. These two graphs demonstrate just that. The first is a graph of the DOW year to date. As of this writing, it stands at 27,870. The highest point was on Feb 12th, at 29,551. We’re within striking distance of this mark.
The second graph is the S&P 500, which you may be surprised to learn, is nearly at it’s peak from Feb 19th, at 3,386! At this moment, it is at 3,383!!
