Second, some disappointed investors will pull out of alternatives, which may boost those who stick it out. There’s evidence this is already happening. According to HFR, hedge funds saw net outflows of $23.3 billion in the first two quarters of 2016. Some public pensions in California, New York and New Jersey have cut back or eliminated hedge funds from portfolios.
Third, with U.S. stock valuations at historic highs and interest rates at lows, it’s far from certain that the traditional U.S. 60/40 portfolio will keep beating alternatives. It could do worse.
But here’s the rub. It may not matter what’s ahead for alternatives because even during the best times, there’s a chasm between the returns of elite investors and everyone else. The reason's simple. The best hedge fund and private asset managers have only so much capacity. Elite investors have the resources to find those managers and the connections to join their funds – two advantages that most investors lack.
This isn't trivial. Consider the difference between the best and worst managers. According to Cambridge Associates, the top quartile of private equity investors received an average net internal rate of return of 21 percent from 1986 to 2013 (the longest period for which data is available); the bottom quartile received 6.3 percent.
The spread in hedge funds is even more alarming. According to HFR, the top decile of funds in the HFRI Fund Weighted Composite gained an average of 47.4 percent from 2000 to 2015, while the bottom decile declined by an average of 21.5 percent.
So investors shouldn't kid themselves when mimicking the elite. Why not give that boring portfolio of stocks and bonds a pat on the back for a year well done?
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
This article was provided by Bloomberg News.