If Hedge Funds Are Lagging, Why Do They Have So Much Money?

By now it’s no secret that equity hedge funds have had a horrible decade. The real surprise is that a record $955 billion was invested in those funds at the end of September 2018.

Which raises the obvious question: Why are so many investors still hanging around?

During the go-go 1990s and the boom years between the dot-com and housing bubbles in the 2000s, the pitch for hedge funds was simple and sexy: “Give us your money and we’ll make you rich!” Sure, the fees were absurdly high, but investors weren’t as fee conscious then as they are now, and in any event, they were making too much money to care.

Managers had good reason to be confident. In 1990, there was a scant $14 billion invested in equity hedge funds, so there were more opportunities for outsized returns than money chasing them. Hedge funds took full advantage, and the HFRI Equity Hedge Total Index returned 16.6 percent a year from 1991 to 2007, outpacing the S&P 500 Index by 5.2 percentage points, including dividends.

Investors piled in along the way, and by the end of 2007, assets in the strategy ballooned to $685 billion, far more than equity hedge funds could realistically manage if they wanted to continue outpacing the market. The 2008 financial crisis didn’t help, either. It whipsawed hedge funds, as it did many other investments, and managers struggled to regain their golden touch. But they weren’t keen on returning the money to investors and giving up their lucrative fees, so they did the next best thing: They pivoted from making money to not losing it.

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