Hedge Funds – Misunderstood, But Still Not Worth It

Cliff Asness has a wonderful new piece on Bloomberg View discussing hedge funds. He basically argues that:

These are fair and balanced statements. And they’re worth exploring a bit more.

The first point is dead on. The media loves to compare everything to the S&P 500 which is ridiculous. The S&P 500 is a domestic slice of 500 companies in a global sea of millions of companies. It neither represents “the stock market”, the “global stock market” nor anything remotely close to “the financial markets”. I have pleaded with people at times to stop comparing everything to the S&P 500. But no one listens to me so it’s not surprising that this continues.¹

Hedge funds are treated particularly unfairly here because, as Cliff notes, they’re not even net long stocks on average. The average hedge fund is only about 40% net long stocks. The portfolio is also comprised of bonds and alternatives making classification difficult to average out. But the point is that the S&P 500 is absolutely not a good comparison.² I would argue that the proper benchmark for all active managers is the Global Financial Asset Portfolio which is the true benchmark for anyone who actively deviates from global cap weighting (which is everyone by the way).

The second point is also clearly true as hedge funds have become increasingly correlated to the S&P 500 over time. Differentiation is what makes alternative asset classes valuable. Unfortunately, you don’t get much differentiation in hedge funds and I don’t think this can reasonably change as the industry grows because, as assets under management grow, the managers will inevitably start to look similar since there are only so many assets that can be held at the same time. The paradox of active management is that the more active everyone becomes the more all this activity starts to look like the same thing (minus taxes and fees).