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You Are The Sucker, And Apparently You Love It

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To return to a favorite subject, the amount of money sophisticated investors throw into hedge funds continues to astound me:

The average hedge fund has gained just 0.3 percent this year, according to HFR’s weighted composite index. That is enough to outpace the 0.75 percent decline this year in the Standard & Poor’s 500-stock index.

Given the staggering amount of fees that hedge fund managers generally charge, this is a terrible return. You would be better off picking stocks from the S&P 500 at random and much better off investing in an index fund.

But wait: this has been a relatively good year:

On that score, however, 2015 has been the exception. The broad hedge fund index has underperformed the stock market in America the previous six years.

Paying somebody massive commissions to do worse than throwing darts at the Wall Street Journal indexes is nutty. And the performance isn’t surprising, since there just aren’t that many foreseeably huge arbitrage opportunities out there:

Take John A. Paulson, who made billions of dollars betting against the housing bubble in 2008 but is nursing losses in three funds this year. He is now raising money for two new funds: a private equity fund and a one focused on health care stocks.

Paulson deserves a good deal of credit for identifying the housing bubble and the implications of converting bad loans into allegedly safe securities ex ante when the correct view was the view of a relatively mall minority. But it’s not as if you can count on this happening on an annual basis. Sometimes the bubble you spot is a bubble. Sometimes it isn’t. Sometimes the market can stay irrational longer than you can stay solvent. Investing with someone on the basis that a good call can be routinely repeated, especially at steep costs, is a really bad idea.

And yet:

The recent fund-raising, however, underscores a bigger trend in the industry: Pension funds still want to invest in hedge funds, even as they complain about high fees and years of disappointing performance.

As long as you can keep finding the marks, there’s no need to stop the con.

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