Hedge funds often get absolutely terrible returns overall, especially once you take care of fees. There are obvious exceptions, but what hedge funds are REALLY great at is making money for the hedge fund manager.
Hedge fund managers generally charge a fee of 2% of the total assets they have under management, plus a 20% skim of any profits the fund makes over some baseline value. Say you have a hedge fund with 50 billion in assets (many are far larger). The management of the fund takes 1 billion in fees right off the top, no matter how well the fund performs. Now, say the fund makes a 5% return, or 2.5 billion. The management takes 20% of that profit, or 500 mil. This means the assets in the fund, post fees, have gone up 1 billion, for a net return, post fees, of 2%, and the hedge fund management has taken in 1.5 billion total, which goes to pay the manager plus his staff, which usually is less than 20 people. Even paying them lavish salaries leaves huge sums going to the manager himself. Hedge fund managers can, and do, literally make over 1 BILLION a year in income for managing the fund. IIRC, the top managers come close to making 2 billion a year in individual income. Great work, if you can get it.
Yet if you look over the long term, the vast majority of investors will make more money off their investments simply by putting the funds into something like a market-tied ETF (ETF = Exchange Traded Fund, which are somewhat similar to the better-known mutual funds) of some kind, probably from Vanguard as they have the absolute lowest fees at about 0.19% (less than 1/10 of even the base fee for a hedge fund). Over the last 5 years, the Vanguard ETFs have, on average, severely out-performed hedge funds, actually. Even if the ETFs got the same returns (5%, say), investors in the ETFs would see their money grow by 4.81% after fees, compared to the 2% in the hedge fund example I gave above. Gosh, I wonder which seems the better value to me.... Yet the ETFs have been OUTPERFORMING the hedge funds, certainly so over the last 10+ years.
From here:
http://investorplace.com/2015/02/vangua ... cD_m_nBVmMThe average hedge fund rose 3% in 2014. Annualized returns have been 6.97% for the past five years 5.1% for the past 10 years, as reported by The Wall Street Journal.
Now compare that to a plain vanilla index fund, such as Vanguard 500 Index (MUTF:VFINX), which rose 13.5% in 2014 and averages 16% annualized for the past five years and 8% for each of the past 10 years.
To be fair, stocks have had an unusually strong 5-year run, and hedge funds are diversified to the degree that matching a 100% stock portfolio is not to be expected in such an environment.
So let’s be a bit fairer and compare one of the best and most boring of Vanguard balanced funds, Vanguard Balanced Index (MUTF:VBINX), with hedge fund performance.
In 2014, VBINX was up 9.8%, compared to the average hedge fund’s performance of just 3%. To capture a broader time period and a full market cycle in a comparison, the Vanguard Balance Index fund’s 10-year annualized return is 7.3%, compared to 5.1% for hedge funds. A simple, low-cost balance of roughly 60% stocks and 40% bonds beats hedge funds!
Even when things are bad, Hedge Funds don't really outperform ETFs:
according to a Vanguard study on hedge funds during the Great Recession, where stocks took a nosedive from November 2007 through February 2009, a portfolio of 60% stocks and 40% bonds had a monthly return of -2.3%, whereas a fund of hedge funds index had a monthly return of -1.6%. That’s not much of a difference in volatility reduction for the added cost of hedge funds.
To sum up: if I had my money in that VBINX fund for 10 years, I'd have made a return, post-fees, of 7.11%. If I had it in an average hedge fund, I'd have made a return of of 2.08% on my money. Not to mention, minimum investment in a vanguard fund is about $3000. Minimum investment in a hedge fund is $1 million+.
So, Lyion, tell me again what value hedge fund managers are actually creating such that they deserve to bring home, PERSONALLY, a billion dollars in income per year?