Julie Jason: Are hedge-fund investments still worthwhile?

Some are saying that hedge-fund returns are not what they used to be.

Whether investors are getting what they bargained for has been questioned time and again. In last week's issue of Barron's, Lawrence Strauss reminded us all of the 1970 Fortune magazine article "Hard Times Come to Hedge Funds," noting that funds "are not growing; in fact, some have suffered large withdrawals of capital, and a few have actually folded."

Investors pulled out of funds during the financial crisis in 2008 and 2009, again in 2011, and they are doing so now, according to HFR, Hedge Fund Research, a provider of hedge-fund data and analysis.

Strauss quoted a veteran hedge-fund manager as saying: "Money goes where money is treated best. You don't deserve a premium fee unless you deliver premium performance." And delivering that is easier said than done, says Strauss.

Performance has to be better than just good to make what some would see as a costly and illiquid hedge-fund investment worthwhile.

And year-to-date performance has hardly been good. According to HFR, 2016 performance through April was positive — but only by a hair (0.3 percent for the HFRI Fund Weighted Index, which is equal weighted). HFRI's asset weighted index dropped by 2 percent, while the S&P 500 index rose 1.7 percent.

The HFRI indices include over 2,000 single-manager funds, reporting net of fees. Since hedge-fund participation in HFRI indices is voluntary, some skeptics believe it possible that poor performers may choose not to report to HFR. (Also keep in mind that indices reflect averages; there are hedge funds that outperform the averages.)

Of course, you can't limit your judgment of an investment vehicle to a short time frame. The longer view tells a different story.

In his March 24 article, Bloomberg Gadfly columnist Nir Kaissar looked at historical returns comparing more recent trends (http://tinyurl.com/jgahxno).

With average annual returns of over 10 percent since 1992, the HFRI beat the S&P 500's average annual return of 9 percent, according to Kaissar. Over the past 10 years, however, the HFRI returned 3.4 percent annually, substantially lagging the stock market, according to Kaissar. During that time, the S&P 500 index returned 7 percent annually.

Performance is not dependent on strategy. "Name your strategy — equity hedge, event-driven, macro, relative value - all of them have weathered the same steady decline in rolling 10-year returns since 1999," says Kaissar.

He asks: "So what's killing the golden goose? In a word: investors. It's likely not a coincidence that as the number and size of hedge funds have swelled, hedge-fund performance has sunk. Hedge funds' success ultimately hinges on two scarce resources — skilled managers and exploitable market inefficiencies — and there simply isn't enough of either one to support a $2.9 trillion industry."

Kaissar adds: "Hedge funds don't suffer from temperamental central banks or errant stock picks or even poor market timing. They suffer from an overabundance of investors. If investors want better hedge-fund returns, they should get out of hedge funds because right now the industry's own popularity is killing it."

If the promise of hedge funds is good net (after fee) performance with low volatility, that's a good combination. You would want that result in a package that's free of restrictions on when you can get your money — however, it is not uncommon for hedge funds to limit withdrawals by time ("lock-ups") or dollar amount ("gates"), and fees can be high ("2 and 20," meaning 2 percent per year plus an incentive fee of 20 percent of net profits). For more about fees, check out "The Origin of Incentive Fees and Other Hedge Fund Trivia," by Timothy Peterson of the CFA Institute, which you can find online at http://tinyurl.com/z27ubp6. For more about hedge funds, read Mario Gabelli's "The History of Hedge Funds — the Millionaire's Club" (Oct. 25, 2000), which I can forward to you (email me at readers(at)juliejason.com).

Are there alternatives? If you are interested in a vehicle that seeks to track the HFRI, there is an exchange-traded fund called ProShares Hedge Replication ETF (ticker: HDG). What's a better alternative? A retiree, widowed investor or someone who inherits wealth may want a solid portfolio of quality stocks and bonds instead.

Julie Jason, JD, LLM is a personal money manager (Jackson, Grant of Stamford, Conn.) and award-winning author.