Against Hedge Fund Investing

I recommend to Retirement Watch readers that a portion of their investment capital be in a long-term buy-and-hold portfolio that I call her “hedge fund” portfolio. This is a collection of mutual funds that use strategies similar to those used by the best hedge funds. The portfoio has done very well for us.

But that doesn’t make me a fan of traditional hedge funds. Most of them are overpriced and don’t deliver what they promise, so they aren’t worthwhile at any price. If you invest in regular hedge funds you have to be very careful about it. I’m not alone at that point. Rob Arnott of PIMCO All Asset All Authority recently joined me on this point. One of the many problems is that most hedge funds these days are run by mediocre money managers who happen to be very good marketers. They don’t take actions differently from other hedge funds and don’t actually hedge anything. You take lower risk and earn higher returns at much lower cost and with daily liquidity by using my portfolio of no-load mutual funds.

But Arnott says that’s a bunch of baloney.

To prove it, Arnott’s colleagues started with a portfolio with a basic mix — 60% stocks and 40% bonds. They then took a look at what would happen if the portfolio was shifted gradually, 10% at a time, into hedge funds. The result: Returns went down, and risk went up as the exposure to hedge funds increased, which is the opposite of what you want.