Main Menu

On the Money

Follow the herd and you’ll end up with the lemmings

Alan SteelUS investor Barry Ritholtz last week published a list of 44 well-supported US based Hedge Funds with their annual performance figures net of charges.

You may be aware that hedge funds are allegedly only suitable for “sophisticated” investors. So what’s the definition of sophisticated in this context ?

Here’s what regulators say…..”A sophisticated investor is a type of investor who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.”  Maybe “doomed” would be better than “deemed”, given the findings of Ritholtz’s report.

Every hedge fund in the list, including those formed more than 10 years ago, contained the words “absolute return” in their title. And they are only suitable for sophisticated (read wealthy) investors. Because they’re managed by alleged geniuses, they’re not cheap. Annual charges are at least 2%, plus it’s common practice to add a 20% performance fee.

So what have they produced to their sophisticated clients ? Of the 32 funds in existence before 2015, only one has produced net returns higher than a simple 60%/40% split between equities and government bonds. And that extra was only at the rate of 2.6% pa, since 2002. Of the remaining 12 launched more recently only 4 produced surplus profits the level of which hardly justified the extra cost.

Most of the hedge funds of were launched between summer 2008 and late 2011, a perfect time you’d think to take advantage of opportunities for outperformance given the chaos caused by the great Financial Crisis of 2008/9. They all failed miserably to deliver. The worst performance came from a fund that produced a staggering 12% pa lower than simply splitting between a US S&P 500 Tracker and Government bonds.

Well known names litter this tale of expensive absolute garbage. Goldman Sachs, PIMCO, Wells Fargo, Prudential to name but a few. Ritholtz concludes investors should avoid the word “Absolute”. Somebody else said “sophisticated investors” should be replaced with “rich idiots”.

What I find amazing is that hedge funds still attract investors despite the collapse in 1998 of Long Term Capital Management, a hedge fund run by Nobel Prize winning economists. More recently we had the Bernie Madoff scandal. Both of these took place in the US and both cost “sophisticated investors” dearly.

Sadly the attraction of absolute return funds doesn’t stop at the other side of the Atlantic. Figures released by the UK Investment industry show the overwhelming choice for new net  institutional investment (read  “big pension schemes”) is, guess what?, absolute return funds, followed by “cheap” trackers. And it seems that in the first quarter of this year private investors followed along. Sadly, fear still sells it seems.

The biggest recipient here of the absolute return fan club is Standard Life GARS ( anybody else think that sounds if it’s short for guaranteed ?) which until recently had attracted over £30 billion in investment.  So how has it performed over the last three years when net inflows were high?

Over the last six months it’s down 3.78%, the last12 months down 3.35% , land the last three years up a total of 4.35%.  How does that compare with the FT All Share Index?  Last 6 months down 2.04%, last 12 months down 8.9%, last three years up a total of 4.47%.

Compare that with our favourite defensive global income fund  at Newton. Last six months up 8.7% , last 12 months up 7.8%, last three years up 20.79%  source Lipper stats).

Investors need to think more carefully before they rush into the latest investment attraction. It doesn’t matter whether you think you’re sophisticated, risk averse or whether you’re attracted to expensive or cheap, if you follow the herd it’s likely you’ll end up with the lemmings.

A survey by US analysts Ned Davis Research looking back over 90 years concluded that the best consistent real returns came from defensive “boring” shares with the highest 20% of P/E ratios.

Or, put simply, what’s inside Equity Income funds. Go check.

Alan Steel Asset Management is regulated by the Financial Conduct Authority. This article contains the personal views of Alan Steel and should not be construed as advice. Do check your individual circumstances with your advisers.

Visit the website at

This is a regular column submitted via the DBdirect service. For details click here.

Leave a Reply

Your email address will not be published. Required fields are marked as *

This site uses Akismet to reduce spam. Learn how your comment data is processed.