Market Sense and Nonsense: How the Markets Really Work (and How They Don't)

Postscript to Part Two: Are Hedge Fund Returns a Mirage?

As this book was entering its copyediting phase, I came across the following startling quote:

If all the money that’s ever been invested in hedge funds had been put in treasury bills instead, the results would have been twice as good.

—Simon Lack

This opening line from Simon Lack’s book, The Hedge Fund Mirage (John Wiley & Sons, 2012), may well be the most damning sentence ever written or uttered about hedge fund investment. But is it true? Well, it’s a true statement about the wrong question. The question that Lack chose to focus on was: How many total dollars have investors earned in hedge funds? The appropriate question, however, is: How much would an individual investor have earned assuming hedge fund index returns?1 Measuring the performance of hedge funds based on total dollars earned, as Lack does, is deeply flawed for two reasons:

1. Investors are terrible in timing and redeeming investments, and measuring performance based on cumulative dollars earned by investors blames managers for the poor timing decisions of investors. Lack reaches his conclusion because hedge funds’ worst-performing year by far, 2008, occurred with hedge fund assets under management (AUM) at a relative peak. Lack states that “in 2008, the hedge fund industry lost more money than all the profits it had generated during the prior 10 years.” But whose fault is that? Who is to blame for investments in hedge funds peaking right before the industry’s ...