Ten years isn’t long to average that out. And anyway risk doesn’t refer to a single observation of past performance. Over most 10 yr periods stocks outperform high quality bonds. That doesn’t mean stocks don’t have more risk than bonds.
Different HF’s now do almost anything anyone can imagine, and many don’t concentrate heavily on just one type of strategy. Some are virtually expensive stock picking mutual funds, and it’s fair to compare directly to other stock funds. But many other HF strategies are totally different, no relation to stock picking at all, no correlation of return to the S&P. It’s become impossible to generalize except to say HF’s tend to have very high fees compared to active stock mutual funds or index funds.
Nor is that the question. The question, to back away from HF’s for a moment and just consider the simpler stock index v conventional paid stock picking adviser case, is why the investor thinks they can pick the manager who will outperform in the future after costs, knowing the mathematical axiom that on average investors paying higher costs must get lower net returns, and active management has higher costs. They might, but the point is that everybody together can’t possibly achieve that, and lack of a solid reason in most cases for a given investor to think they are better than average at predicting manager success, which they’d have to be for it to make sense.
Back to HF’s, most people aren’t eligible to invest anyway, or only indirectly through additional layers of fees. If the average investor forgets about HF’s, the chance they are doing themselves a serious disservice is basically zero. The one minor potential exception is where now some providers offer HF-like strategies at lower costs (liquid alternative MF/ETF’s, some robo-advisors). Here it’s possible the average investor might consider it, but if so first has to understand risk and correlation. This isn’t a minor technicality, it’s the whole reason anyone would rationally consider such investment strategies. If looking for raw superior return, they are basically on the wrong track, even if as D18 pointed out the famous/infamous Buffett/HF bet was taken up by somebody on HF side. But the bet still projects a basic misunderstanding of what most HF’s and ‘HF-type strategies’ are actually trying to achieve.
Even if a given fund does outperform the market over some time span, does it do so because of the skill of the managers (in which case one would expect it to continue to outperform), or does it do so simply by luck (in which case you wouldn’t expect its future performance to be any better than anyone else’s)? How can you tell the difference?
That was a fantastic Frontline episode, and enlightening to me. Some of it I had already suspected, but they explain the background which confirmed my hunches.
I know it’s not an academic source, but there have been other prominent investors who have argued that index funds are better for the average investor. Warren Buffett, Charles Schwab, John Bogle (in the Frontline piece), and others. However, the caveat is that if you actually deal with someone who has the time to do real research on companies, it is possible to beat the indexes. The problem is that most investors don’t devote the time and due diligence that is required. It requires an extraordinary amount of work and analysis. You have to know how to read financial statements. Most financial advisors are salespeople, not actual investment experts, and even investment experts themselves vary in terms of quality.
This was the teardown of the once much touted “15 straight years beating the index” performance from Bill Miller’s actively managed Value Trust Fund at Legg Mason. Statistically analyzed, over all the active fund managers out there, sheer randomness would predict it likely that one good would get hot and look good - every bell curve has tails.
The distribution of actual fund returns has fatter tails than the expected bootstrapped distribution (see Fig. 2 in the Fama and French paper linked above, which shows the cumulative distribution of fund returns before fees). This is evidence that there are skilled fund managers that can produce superior returns, but also evidence for total putzes that consistently lose money.
Unfortunately there’s no way to figure out whether high returns were produced by luck or skill. And even worse than that, the superior returns are completely wiped out by fees (see Fig. 1). The only people benefiting from genuine investing skill are the fund managers themselves, and they get similar benefits even if they’re terrible…