Much is being of the fact that bonds and even equities have easily outperformed average hedge fund performance over the past decade. As The Economist notes the S&P 500 has beaten an index of hedge fund returns in 9 of the past 10 years and quite handily in 2012.* They posit a number of explanations including the fact that institutionalization has dampened manager’s willingness to take risk. In short, the attraction of 2% management fees on a big pile of institutional cash is far more compelling than a risky 20% performance fee. They conclude:
The hedge-fund industry’s trump card is that a handful among them have delivered stellar returns over the long term. But the same is true of any sort of investment. The average hedge fund is a lousy bet, and predicting which will thrive and which will disappoint is a task that would tax even a Nobel prizewinner.
Hedge funds have a number of strikes against them including high fees, opacity, illiquidity and complexity. One could argue that hedge funds and all other investors in search of alpha are going to have to embrace even greater levels of complexity in order to outperform. This is due in part to the growing rapidity in which research findings are translated into strategies that, now faster than ever, get played out. Michael Harris at Price Action Lab notes how this crowd of ‘fundbusters’ is changing the investment landscape. He writes:
The fundbusters team includes your familiar quant blogger, your local college professor and everyone else who can identify an edge and publish the results in a journal or in the blogosphere. As fundbusters keep on getting satisfaction from publishing edges rather than from using them, the rate of failure of funds of all types will increase and managers will be driven towards higher complexity edges.
The problem in this is that complexity works directly against the individual investor. In this blog and in my book I talk about how a simple, albeit less than optimal, investment strategy that is easily followed trumps one that will abandoned at the first sign of underpeformance. Mark Dow at Behavioral Macro notes the ongoing futility of trying to get just one more piece of information from the financial media industrial complex in order to generate an edge. He notes how it isn’t a lack of information that holds us back but rather our own emotions. The best investors recognize their own emotional flaws and design their strategies in order to mitigate their own flaws. Dow writes:
Most importantly, you, YES YOU, are not exempt from these flaws. This includes me…Individual investors would add more value to their own portfolios if focused on building an investment approach that mitigated emotional impulses. Until this is done, ain’t nothin’ gonna work.
My thought is that ever greater simplicity is the only way to combat these impulses. Every time investors add another strategy, rule or watch list they run the risk of taking their eye off the ball and making impulsive decisions. In this light a simple strategy of following broad based indexes, minimizing costs and reducing the number of decisions you need to make increases the probability of meeting one’s investing goals. One can see how having hedge fund envy can only work against you. The Economist writes:
The best way for investors to play the odds is to choose low-cost ETFs or trackers and diversify geographically and across asset classes. It is not an exciting strategy. It will not bring anything to brag about at dinner parties. But it will mean that more of their money stays in their own pockets, and less goes to buy other people’s mansions in Mayfair and the Hamptons.
For most of us life is already complicated enough with layering on additional complexity through our investments. Like Om Malik who is consciously curating his life to emphasize quality over quantity, there is never a better time of year to think about curating your investing life. Are you chasing performance (and complexity) to little avail? If so, it might make sense to start paring down your goals (and strategies) and in so doing free up your time for other more worthwhile endeavors. In the end for the vast majority of us simple strategies, easily followed, trump complex ones any day.
*That being said the S&P 500 is a not altogether relevant index to compare hedge fund index returns.