Hedge Funds Score Big Gains

After last week’s article on how hedge funds fail at a rate worse than New York restaurants (thanks to @Jessica_OGIQ for the funny comparison), it seems the newspapers decided to find a silver lining in their lackluster performance. The Wall Street Journal points out how “stock picking” hedge funds are doing much better than the S&P 500 and credits the outperformance to “booming M&A.” It seems like every market movement needs a reason and usually those reasons are applied post-hoc.

This article is either misleading or misinformed. Investors do not create returns. They simply capture returns across the different sections of the stock market that present themselves with varying levels of systematic risks. These different pockets of returns are true asset classes. The S&P 500 is utilized as a proxy for large companies. There are different sections of the stock market beyond the S&P 500 available for investors to passively capture. I have to think that the Wall Street Journal and hedge fund managers know that the stock market exists beyond a collection of 500 large stocks in the U.S.

Under this lens, “stock-picking” hedge fund managers would have been better off capturing market returns across different areas of the market rather than concentrating on picking winners. The Russell 2000, a small cap proxy, and the MSCI- EAFE, an international large stock proxy, have returned year-to-date 6.5 percent and 7.6 percent. Both were well above the “market beating” return of 4.99 percent.  (As a complete aside, even though the numbers fall in our favor, it is impossible to determine real skill based on a six-month year-to-date return, but for the purposes of reviewing the article, we’ll run with it.)

Why weren’t these passive very investable indexes mentioned in the article? It seems to me investors would have been better off dumping these alternatives in favor of a multiple asset class basket of funds capturing different systematic risk premiums across the global stock market. That mix is ultimately dependent on what you want to accomplish with your wealth.

 

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