Originally published on the Huffington Post, October 10, 2017
Rich people are different from you and me, but not in the way you probably think.
The smartest of them all
The smartest rich people in the history of the world are hedge fund managers. How smart are they? Take a look at this list of the top-earning hedge fund managers in 2016. Paul Singer, who runs Renaissance Technologies, tops the list. His 2016 earnings were $1.6 billion. Even the 10th person on the list, Israel (Izzy) Englander, with Millennium Management, took home $410 million.
Just because these managers made a ton of money doesn’t make them “smart.” Here’s what does. They’re selling an expertise (stock picking, market timing) that doesn’t exist, to sophisticated investors who should know better but are blinded by the allure of being part of an exclusive club.
Take a look at this analysis from Bloomberg. It compared the results of investing in Vanguard’s Balanced Index Fund (through November, 2016), to the HFRI Asset Weighted Composite Index, a global, asset-weighted index comprised of over 2,000 single-manager funds that report to the Hedge Research database.
The Vanguard balanced fund invests roughly 60% in stocks and 40% in bonds by tracking two indexes that represent broad barometers for the U.S. equity and U.S. taxable bond markets. Its expense ratio is a minuscule 0.07%. You can buy it yourself on Vanguard’s website, without paying any fee to brokers or advisors.
If you were enticed by having your money managed by a “super guru” running a hedge fund, you could pay an average fee of 2% of assets under management, plus 20% of investment profits. This is a classic example of “heads I win, tails you lose”, since 2% alone is a hefty fee, even if the fund just breaks even.
What did you get for these obscene fees in 2016? How about “massive underperformance”? The no-brainer Vanguard Balanced Index Fund returned 7.5% (through November 2016). The HFRI Asset Weighted Composite had a return of only 2%. Investors would have earned 400% higher returns in the simple index fund.
The dismal performance of hedge funds in 2016 was not aberrational. According to CNNMoney, “…the HFRI Fund Weighted Composite Index, has generated an annualized gain of just 1.7% over the past five years. Compared to that, the S&P 500’s average annualized return for the same period was 11%.” This massive disparity makes 2016 look like a relatively good year for hedge funds!
According to financial author, Larry Swedroe, for the 10-year period ending 2016, the HFRX Global Hedge Fund Index (which is designed to be representative of the overall composition of the hedge fund universe) produced negative returns of 0.06%. Every stock and bond asset class generated higher returns during this period.
Think about that for a moment. For the decade measured, the issue is not whether these managers had superior skill. On average, they were among the worst fund managers imaginable.
I told you they were “smart.”
Smart investors buy index funds
Keep this in mind the next time you read articles trying to convince you to invest the way “rich people do.”
Really “rich people” manage hedge funds.
Really “smart people” invest in a globally diversified portfolio of low management fee stock and bond index funds.