Our Insights

About personal finance, investments and markets.
April 26, 2016

Reality check ‘alternative investments’

The typical marketing pitch for alternative assets includes a reference to capturing most of the upside while protecting you in down markets. Sounds too good to be true? As alternative assets are now increasingly being marketed at individual investors, it is maybe time for a reality check. Here we analyze the most recent performance of hedge funds to see if the claim of superior investment prowess holds true.

If you want a good hedge, go to a garden centre

Remember the first quarter of this year? Most global equity markets were down double-digit in January and early February before recovering their losses until the end of the quarter. Quite a roller-coaster ride. Given the freedom to move across asset classes as well as go long/short, this is exaxctly the kind of market environment that agile hedge funds should be able to exploit – one would think. Unfortunately for investors, so far 2016 has not been too kind. The HFRX Hedge Fund Index underperformed most major equity and bond indices.

 Jan-Feb 2016 Performance
HFRX Global Hedge Fund Index-1.9%
S&P 500 Index+1.4%
MSCI All Country World Index+0.4%
5 year US treasury note+3.4%

Was Q1 2016 just an exception for the hedge fund community? Not really. If you look at the annualized performance of the last 10 years, the same Hedge Fund Index underperformed materially. The returns were well below 1 year term deposits. Thanks for playing…

 Annualized return 2006-2015
HFRX Global Hedge Fund Index+0.1%
S&P 500 Index+7.3%
MSCI All Country World Index+4.6%
5 year US treasury note+4.5%

Why the big difference between the marketing pitch and the actual performance? We think the key issue is costs. Alternative assets as well as the banks and brokers that sell them keep most of the upside for themselves through various fee structures. Basically once your factor in the 2% annual expenses and 20% performance fee most funds charge, you are not getting a get-rich bargain at all here.

We have said it before: alternative assets are no so much a distinct asset class as they are a wealth transfer mechanism. From your pockets to the pockets of the fund managers and the banks. In April this year, UBS, one of the largest wealth managers, advised their clients to increase their hedge fund exposure to 20%. One doesn’t have to be a cynic to see who benefits from a shift towards higher fee funds. We find the argument in favor of hedge fund not very compelling: assets will have a lower return profile going forward. To choose a higher fee manager from a category that has displayed a poor performance historically is not the advice we would give to our clients.

More examples?

Not everybody may be familiar with the HFRX Global Hedge Fund Index. We have therefore added a table with some hedge fund products that are available for retail clients in Germany. The annualized 5 year performance ranges from -3% to +2%. To keep this in perspective, those results were delivered during what was probably one of the strongest bull markets in equities, bonds and credit. Caveat emptor.

FundsAnnualized 5 year performance
db x-trackers Deutsche Bank Hedge Fund Index-1.8%
Credit Suisse CS AllHedge Index Fund-2.6%
Sauren Global Hedgefonds+1.6%

Summary

When your wealth advisor talks about ‘alternative investments’, maybe you should watch your wallet. If you would like to know if there are better ways to invest your wealth, please don’t hesitate to get in touch.