Love the Player, Hate the Game

Hedge Funds Bear the Blame for Looking Bad
They compared themselves to the S&P 500, then complained when they underperformed.
Bloomberg, June 1 2018



A couple of weeks ago, Barron’s interviewed mutual fund legend Jack Bogle, the inventor of the index fund and founder of Vanguard Group. One intriguing exchange caught my eye:

Barrons: “Favorite hedge fund?”

Bogle: “Reluctantly … anything run by Cliff Asness”

As some regular readers may have noticed, I engage in this little balancing act: I am critical of the hedge fund industry while also admiring many of its leading managers.

This isn’t a contradiction. The alternate-investments industry is rife with problems, many of them rooted in the costs relative to performance. Yet it is also populated with smart and insightful folks who have expanded our understanding of complex investing issues. We understand more about risk and the elements that drive markets today than we otherwise would have without the incisive research and commentary published by these managers.

One such source of analysis is Cliff Asness, founder and chairman of AQR. I confess to being consistently delighted 1 by Asness, despite occasionally being on the receiving end of his criticism. Unlike many who are endowed with superior math skills, he is both articulate and funny.

Obligatory genuflection out of the way, I want to take a closer look at his recent online commentary, “The Hedgie in Winter.” Partly because I disagree with some of it, and partly because he makes an example of me, today I shall defend my critique against his.

Asness writes:

“Analysts and authors often compare hedge fund returns to 100% equities (most often, the S&P 500). Then, almost always based on the last nine years since the global financial crisis (GFC) lows, they declare hedge funds an epic disaster. That’s just flat-out wrong. Comparing hedge funds to 100% equities would be a bad comparison at any time. To make things worse, this comparison is done over a cherry-picked time period.”

Cherry picking is never a good thing, and using the wrong benchmark is similarly frowned upon. Examine any list of disparate and exotic strategies – long only, short bias, global macro, special situations, distressed debt (see this for a mostly complete list of hedge-fund investing strategies) and you can see why finding an appropriate benchmark has been called a “chronic difficulty.” 2 Using broad, U.S.-based large cap indexes such as the Standard & Poor’s 500 Index as the benchmark simply makes little sense for many funds.

However, if we are to lay blame on anyone for that benchmark, the fault lies not with the analysts or news media (or me for that matter), but with the funds themselves. Historically, they have compared their performance to the S&P 500 and other large cap indexes. I want to repeat: It wasn’t the critics of hedge funds that did this; it was the fund managers themselves that made these claims. Once the industry’s assertions of outperformance versus broad markets became part of the sales pitch, it shouldn’t come as a surprise that others used the S&P500 as the benchmark of choice.

Asness is a notable exception to this marketing approach. 3  He believes hedge funds should actually hedge, and thus should underperform big cap equities during a broadly rising market like the one we’ve had for much of the past decade. The tradeoff is that they should outperform once the bull market fades.

As to the cherry-picked timelines, allow me to suggest two broad analyses that are not cherry-picked, but reach similarly dismal conclusions. In early 2017, my colleague Ben Carlson looked at hedge-fund performance across three distinct eras: 1998-2016, 1998-2003 (sometimes referred to as the golden age of hedge funds) and 2004-2016 against a simple investment portfolio made up of 60 percent equities and 40 percent bonds. Carlson found that the bulk of outperformance came “during the glorious five-year period spanning the lead up to and aftermath of the tech bubble,” in other words, from 1998 to 2003. Since then, there has been dramatic hedge-fund underperformance.

Simon Lack, in his 2012 book, the “Hedge Fund Mirage,” is even harsher: “if all the money that’s ever been invested in hedge funds had been in Treasury bills, the results would have been twice as good.”

The really problematic issue for hedge funds is that the space has become too crowded. Carlson noted that in 1998, there were about 3,200 hedge funds with roughly $210 billion in assets under management. Today, more than 11,000 hedge funds manage more than $3 trillion in assets.

“Size is the enemy of outperformance,” Carlson notes. But I suspect it’s even worse than that: Hedge funds, like everything else, follow Sturgeon’s Law that “ninety percent of everything is crap.” In other words, the key to outperformance is avoiding the detritus that infests the 90 percent and owning the exceptional 10 percent. That, I’m afraid, is easier said than done.


1. Asness was a guest on Masters in Business in 2015, and was at the evidence-based investing conference my firm produced in New York last year.

2. See “Higher risk, lower returns: What hedge fund investors really earn,” by Ilia D. Dichev, Gwen Yu, Journal of Financial Economics 100 (2011), pages 248–263.

3. He has long been a critic of hedge funds for a) charging too much; and b) for not hedging.


Originally: Hedge Funds Bear the Blame for Looking Bad


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