While there is no evidence that hedge funds are falling out of favor, their scale is making it more difficult for the hedge-fund industry as a whole to produce better results than other asset classes, said Simon Lack, a former executive at New York-based JPMorgan Chase & Co. and author of the 2012 book The Hedge Fund Mirage.
"You have more money chasing fewer opportunities," he said.
The main Bloomberg hedge fund index, which is weighted by market capitalization and tracks 2,697 funds, fell 2.2% a year in the five years ended June 30. The Vanguard Balanced Index Fund, which has a 60/40 split of equities and bonds, gained 3.5% annually and the S&P 500 Index gained 0.2% a year.
The Vanguard fund had also beaten the HFRX Global Hedge Fund Index, a measure of hedge fund performance with a longer history, every year since 2003.
Investors still expect hedge funds to outperform in the long run as low bond yields and a slow-growing global economy limit the gains from stocks and bonds, said Don Steinbrugge, managing partner of Agecroft Partners LLC, a Richmond, Va.-based firm that advises hedge funds and investors. Hedge funds continue to make sense for investors because over time they have boosted returns and protected investors in difficult markets.
From the end of 2000 through 2002, when the S&P 500 index fell 17% annualized and the Vanguard Balanced Index Fund lost 6.3%, hedge funds returned 6.7% annually, according to data from Hedge Fund Research Inc.
Hedge funds also beat the balanced fund in 2008, the second quarter of 2010 and the third quarter of 2011, periods when stocks tumbled, Bloomberg data shows. Hedge funds lost 19% in 2008 compared with a decline of 37% for the S&P 500 index and 22% for the balanced fund.
Citigroup, in a June report, concluded that "lingering concerns" about recent hedge-fund performance would not stop institutional investors from putting more money into them. The industry could attract an additional $1 trillion by 2016, Citigroup predicted, as public and private pension funds need strong investment returns to meet their long-term obligations.
Golden Years?
"What a drag it is getting old," sang Mick Jagger in the opening line of the Rolling Stones' 1966 hit, "Mother's Little Helper," which was a commentary on barbiturate use by housewives. The line also seems to encapsulate a recent report from iShares arguing that an aging population in the developed world-and possibly in China, too-bodes ill for people's future economic growth prospects and equity market performance.
The report, Not So Golden Years: How an Aging Society Can Impact the Markets, makes the case that countries with unfavorable demographics (i.e., too many aging folks and not enough young people to replace them) will experience shrinking labor forces, less economic growth and, ultimately, lower equity multiples.
In addition, older investors have less need for stocks, which crimps demand for equities and also contributes to lower multiples. The implications of that are twofold. For starters, while equity multiples in the developed world look reasonably priced and cheap relative to bonds, constrained growth could mean multiples don't revert to their historical averages. In addition, slower growth in the developed world could mean that the historical premium developed nations have enjoyed over emerging markets (roughly 35%) might contract over time.