Why The Biggest Hedge Funds Have Failed This Year

Why The Biggest Hedge Funds Have Failed This Year

over 3 years ago3 mins

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Hedge funds have historically thrived when markets turn volatile. But 2020’s been different: the average hedge fund hasn’t made investors any more than a passive fund tracking the US stock market… 🙄

What does this mean?

If you had to use one word to describe this year, “volatile” might be a solid pick. And volatility in stock, bond, currency and commodity markets is exactly what hedge funds were designed to thrive on. These investments pride themselves on their ability to make money no matter what’s happening to market benchmarks – but particularly when they’re heading down.

Yet in spite of 2020’s big ol’ market swings, the average hedge fund’s gain for the year stood at just 0.6% earlier this month – lower even than the S&P 500’s relatively meager returns. Instead of paying hefty fees to earn less, investors could have picked up a much cheaper exchange-traded fund (ETF) tracking the US index and turned a 6% profit 👍

Hedge funds’ average performance has been dragged down by the largest such firms, which have managed to lose 4% in 2020. That’s despite their reputation for enhanced stability: data from the last decade shows big funds losing less than their smaller counterparts nearly two thirds of the time.

This year, however, smaller “multi-strategy” funds – those with less than $500 million under management – have, according to research firm Pivotalpath, delivered 6% better returns than their larger peers. That may be partly due to their ability to invest in very niche trading strategies that simply don’t have the capacity for the billions of dollars big hedge funds need to invest to make a meaningful change to their portfolios.

2020 relative hedge fund performance
Large hedge funds have been a bummer in 2020 (Source: Bloomberg)

Why should I care?

Hedge funds form part of the investment category known as “alternative investments” – and while these aren’t a mainstay of most portfolios, you might want to consider taking the plunge. Despite hedge funds’ mixed performance this year, diversifying beyond just stocks and bonds could help your portfolio weather the next major market downturn. In 2008, the average hedge fund lost 18% – and although this was the sector’s worst year on record, it’s not so bad when you remember the US stock market fell 38% 😯

Stocks have outpeformed hedge funds over the past decae
Source: Hedge Fund Research, FT

With the US election around the corner and the pandemic causing havoc worldwide, both volatility and the probability of downward market moves are likely to remain high. This may be as good a time as any to diversify your portfolio – and the most common recommendation for individuals, according to investment platform DiversyFund, is to put around a fifth of your portfolio in alternatives, which also includes things like real estate, private equity, and art.

Even if you’re not a direct hedge fund investor yourself, your retirement pot may well be; pension funds are among the biggest backers of the best-known hedge funds, and the latter’s fortunes could be a major factor in the overall performance of your superannuation scheme.

While hedge funds themselves aren’t easily accessible to the average individual, there are an increasing number of ETFs available that track their performance – while bringing the added benefit of a smaller price tag. And given what’s gone on this year, hunting down an investment which follows those outperforming smaller hedge funds may be a particularly good idea… 😉



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