Many, even most, of the critics come to wrong and distorted conclusions based on these improper comparisons. Although recent returns are far from hedge funds’ best results, they are also not the disaster often proclaimed.
To be sure, there are things to worry about in hedge-fund land. First, my long-standing critiques -- that hedge funds need to hedge more and charge less -- still apply. Second, this problem has grown as hedge funds have become more correlated with traditional markets, which is of great concern today given the likelihood that traditional asset classes now offer a lower long-term expected return than usual. Third, hedge-fund performance, even when compared to the right amount of stock-market exposure, has retreated in the past few years. Fourth, although managers can’t fully control their returns, they have more control over how much risk they take. There is evidence that hedge funds as an industry are less aggressive than they used to be. This could be a sign that the value proposition is weakening as hedge funds simply do less (the equivalent of closet indexing in a long-only world). Perhaps this means that they manage too much money.
Then again, one of the truisms of markets seems to be that investors and pundits overreact. Only time will tell if the hostility to hedge funds is an accurate harbinger of tougher times to come or the typical knee-jerk reaction that comes with any period of below-norm performance.
By charging so much, sometimes for fairly simple and known strategies, hedge-fund managers set expectations too high and gain no slack for the inevitable tough times all investments face. They are learning that now. I hope that investors will sift through the overblown case against hedge funds and use this moment to exhort the industry to become better by charging less, hedging more and providing real diversification.
Clifford Asness is the founding and managing principal of AQR Capital Management LLC in Greenwich, Conn., a hedge fund and asset-management firm, and is a frequent commentator on financial markets.