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Wednesday, May 22, 2024

Investors’ renewed interest in hedge funds could be ill-advised

Superheroes can be useless when times are good. If Gotham was a peaceful place, Batman might just lounge around in a mansion upstate. And Superman would only dive into a phone booth to switch into his blue-and-red lycra when someone was in trouble. For many years, financial markets were calm. From 2010 to 2020, the S&P 500 index kept climbing, as did bond prices. Investors were more concerned about missing out on the bull market than the risks ahead. For hedge funds, which aim to provide stability during turbulent times, the outlook was grim. They strive to give returns that aren’t tied to the larger stock market to ease the blow when markets fall. They’re like the superhero hedge-man who swoops in to save the day.

Hedge funds had a tough time in the 2010s. Investors stuck with them for the first half of the decade, but as their returns continued to fall behind the stock market, they lost net assets. In the second half of the decade, hedge funds lost money and investors turned their backs. More funds closed than opened almost every year after 2015.

But now, things are looking up for hedge-man. Money has been flowing into funds every quarter this year, and if things keep going this way, 2023 will be their best year since 2015. The total invested in funds is now over $4 trillion, up from $3.3 trillion at the end of 2019, and more funds are opening than closing.

The renewed interest in hedge funds may be influenced by last year’s success. Hedge funds outperformed the market, which lost 18%, while hedge funds only lost 8%. However, over the past decade, hedge funds have generally underperformed American equity indices. There’s also a sense that the good times of easy monetary policy and high returns in the 2010s are over. As the performance of hedge funds tends to improve during periods of rising rates and challenging asset returns, more investors are flocking to them.

But today’s markets are high-tech and fast-moving. In the 1980s, you could gain an edge by reading the newspaper on the way to the office, but now information spreads instantly, and there’s increased competition among traders and trades.

It’s no wonder investors are turning to hedge funds for security in a time of high volatility, but it’s worth remembering that in 2008, a dreadful year for stocks, Warren Buffett was beaten by hedge funds. But then index funds outperformed hedge funds in the following nine years. As the dawn of a new era approaches, investors may wish they had stayed with their index funds.

If you want to delve deeper into financial markets, you can check out our columnist Buttonwood’s other articles. You can also learn how the Buttonwood column got its name. And remember, even superheroes need a helping hand sometimes.

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