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Market Outperforms Hedge Funds?

Date: Thursday, December 9, 2010
Author: Gary Kaminsky, CNBC

What do hedge fund managers and closet indexers have in common? More than you think, according to a new study by Emory and Harvard Universities.

The report examined over 11,000 hedge funds and their respective performances going back as far as 1980. And despite record inflows of cash, and massive pay packages for fund managers, do you know what the aggregate return was for the average hedge fund over that time? On a dollar weighted basis, it was 6 percent.

To put this in some perspective, you could have put the same amount of money in risk-free U.S. Treasuries and earned about 5.6 percent over that time.

More shockingly, the study, aptly titled "Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn," found that simply buying and holding stocks over that period produced even better returns.

So what gives? Why do investors continue to plow money into this space when, at least over time, they can generate similar returns simply buying government bonds?

I suspect it has something to do with the allure of alternative asset managers. Put the word "hedge" in front of an investment firm's title, and potential investors will feel as though they have entered some exclusive club, the investment equivalent of walking into Lavo on a Thursday night.

But like most hot spots, you usually can't get in, and if you can, you probably don't want to.

Don't get me wrong. Just like mutual funds, there are a handful of hedge funds that add value over time. But the idea that the asset class as a whole must play a role in a serious investor's portfolio has finally been debunked.