Rob Arnott, one of North America’s most prominent financial analysts, thinks that the world’s hedge funds are a bust and he’s set out to prove it. An article published today by Fortune details the analysts study of the investment vehicles and his disappointing results. Rob Arnott takes a look at some of the promises of hedge funds offered in their sales pitches.
The two cornerstones of the general argument for investing in a hedge fund is that the vehicles offer higher return at lower risk. That’s the reason management fees tend to be so successful. The first part of that offer is easily disproved. Hedge fund returns have, using a wide index, underperformed the overall market for four years running.
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Many funds, according to a Bank of America Corp (NYSE:BAC) report, were pretty close to simply indexing their funds to the S&P 500 in 2012. Those vehicles were charging fees for correlation with the wider market. There’s clearly something wrong here, and Rob Arnott has some ideas about what that is.
The real issue, according to Arnott, is the vast expansion of money coming into hedge funds from pension funds, representing the hard earned wealth of the middles classes. This has caused a ballooning in the value of assets held by hedge funds. The number has tripled in the last decade to $2.25 trillion, and returns do not live up to expectations.
Rob Arnott’s experiment, in which he picked a basic portfolio, 60 percent stocks 40 percent bonds, and shifted the portfolio gradually to hedge funds, showed that each movement into hedge funds caused an increase in risk and a decrease in returns. Over a period of fifteen years, hedge funds did a little better, but investors would still be better served by a passively managed mix of commodities, equities and other assets.
Arnott believes that there are a certain amount of outstanding hedge funds in the market, but they are overshadowed by a glut of bad or mediocre funds driven by the huge amount of public money flowing into the sector, and the promises of hedge fund marketeers.
His work is sure to cause a debate about the place of hedge funds in the investment world, and that debate should be welcomed given the amount of the public’s money on the line.