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Short Summary
Main recommendation: Avoid hedge funds and invest in low-cost, diversified index funds instead, since Ben Felix says hedge funds charge high fees, underperform simple index portfolios, and carry extra risks like illiquidity and leverage. He argues that hedge funds' appeal comes from exclusivity and the belief that investors deserve more than the market return, not from evidence of superior results.
Key Points
- Hedge funds charge typically 1-2% of assets under management plus 20% of excess performance, yet the speaker cites research by Harry M. Kat and Gaurav S. Amin suggesting their low market correlation comes from strategy type rather than manager skill.
- From January 1994 through November 2017, the Credit Suisse Hedge Fund Index returned an annualized 7.71%, versus 9.19% for a globally diversified equity index fund portfolio and 7.75% for a 60% stock / 40% bond index portfolio.
- Hedge funds can impose lock-up periods and suspend withdrawals after the lock-up, often at the worst possible time, such as during a crash.
- Hedge fund return distributions show negative skewness and high kurtosis, meaning most investors lose while a few win big, with more extreme outcomes than a normal distribution would predict.
- Low correlation with stocks can rise sharply during crises; the speaker cites the 1998 and 2007 financial crises as examples.
- Past performance is a poor predictor: the Tiger Fund, formed in 1980 with $10 million, averaged over 30% annual returns for 18 years, grew to over $22 billion by 1998, then lost $10 billion before closing in 2000; most investors reportedly lost money by buying after the strong returns.
Details Worth Noting
- Concrete instructions: Do not allocate to hedge funds; the speaker says he does not recommend them in the portfolios he oversees. Instead, consider a globally diversified index fund portfolio, or a conservative 60% stock / 40% bond index portfolio, as the benchmark alternatives discussed. These fee structures, lock-up terms, and withdrawal suspension rights are the specific costs and restrictions the speaker highlighted as risks of hedge fund investing.
- Alfred W. Jones created the first hedge fund in 1949 (A.W. Jones & Co.), using leverage and short selling to remove market risk, and structured it as a limited partnership to avoid regulation.
- A 2000 AQR Capital Management study found many hedge funds took on significantly more risk than their benchmarks by investing in illiquid assets.
- CalPERS, a large California pension fund, exited hedge funds in 2014 due to cost, complexity, and risk; other large pension funds have since followed.
- Eugene Fama advised avoiding high fees and said "you can forget about hedge funds."
- Warren Buffett won a 10-year million-dollar bet against a hedge fund manager who selected five hedge funds to beat the S&P 500; the index won easily.
Bottom Line
Hedge funds' exclusivity and high fees do not translate into better returns or lower risk, so for most investors the simpler, cheaper index approach is the more reliable path.
