Consistently Performing Hedge Funds: Rarer Than a Needle in Many Haystacks

Determining which hedge fund will be advantageous for a particular portfolio isn't just as difficult as finding a needle in a haystack. It's roughly akin to finding a needle in a field full of haystacks.

Finding a needle in multiple haystacks is more difficult than finding it in one. This is akin to determining which hedge fund will be advantageous for a particular portfolio. It is difficult and tedious work, often without positive results.

Hedge funds are in the news. By and large, they have lost their luster. Insurance companies, pension funds, and institutional investors are divesting from them. This is because they are performing poorly in spite of their promise of low volatility and higher returns than the market. The explanation for their dull performance is multifactorial.

First of all, hedge funds charge high fees. This means even if they make a profit, less is returned to the investing party.

Secondly, the funds are largely opaque. Investors frequently don’t know where their hedge fund invests their money. It could be duplicating an existing investment in the portfolio in which they are placed. If this isn’t recognized, risk or reward could be doubled for that stock.

Thirdly, there are too many hedge funds pursuing the same options; about 10,000 in number. Think Valeant International, a stock that recently dropped precipitously; multiple hedge funds were invested in it. With so many at the exit at the same time, the price did nothing but nose-dive and those that were late in the queue suffered a blow to their sell price (lower than they hoped or expected).

Fourthly, hedge funds tend to do less well in bull markets. In this type of market cycle, little hedging is needed if any at all. We have been in a bull market and it may be continuing. And, lastly and importantly, hedge funds are difficult to understand because of their complex and often secretive strategies. Doing due diligence takes time and effort. Few individuals have the background and time to manage this. Among insurance and pension funds plus institutional investors, the companies assume their research team is equipped to execute this task ably. Yet, the time and attention to detail that is needed may be overwhelming to already busy analysts.

On the plus side, when chosen carefully, hedge funds theoretically could do what they claim, lower volatility and increase performance. The question is, which ones do this and with what regularity? Finding that fund or funds could truly be more difficult than finding one needle among many haystacks.

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