Weekend reading

Some good reads from around the Web.

Every now and then someone pats me on the head and tells me I don’t understand that the real smart money is in hedge funds.

They might tap their nose and explain you have to be “in the know”. More than once they’ve been in the know for about six months – or in fact they aren’t invested in hedge funds at all, but aspire to be. I’ve not come across many long-term hedge fund promoters.

While I believe passive investing is the best choice for most people, I am far from a pure passive investor myself. Nor do I think all hedge fund managers are stupid – quite the opposite. More Money Than God was one of my favourite reads of last year. There was much financial high adventure to thrill to from the hedge funds profiled, even accounting for survivorship bias and so forth.

But I liked that book – and I invest in my own stock picks – because I am vain, self-deluding, and greedy enjoy the challenge of trying to beat the market, not in the sure expectation of doing so.

In contrast, there’s no reason to invest in an actively managed fund except in the pursuit of higher gains. Passive funds will give you diversification more cheaply, and more accessibly. And unfortunately for all concerned, the majority of managed funds fail to beat the market, not least because of the fees they charge.

Which brings us to hedge funds. Time and time again we’ve seen evidence that most cannot consistently jump over the hurdle of their “2/20″ fees in order to deliver value for investors over the long-term.

They didn’t even do very well in the period spanning the last stock market crash, lagging a cheap tracker/bond combination. Their much vaunted defensive ‘hedge’ proved as illusory as a Quaker Gun.

For many years, hedge funds have been unable to advertise in the US. Supposedly only sophisticated and rich investors were capable of understanding why it was a good idea to give a fund manger huge chunks of your money each year. But the rules could be set to change.

That’s a bad idea, argues the inimitable Larry Swedroe on CBS:

The performance of hedge funds demonstrates very clearly that they aren’t investment vehicles, but rather compensation schemes designed to transfer assets from the wallets of unsophisticated investors to the wallets of the purveyors.

For the past one, three and five years ending July 2012, the overall HFRX Global Hedge Fund Index produced annualized returns of -5.2 percent, 1 percent and -3.4 percent per year, respectively. […]

For the same one-, three- and five-year periods, the S&P 500 returned 9.1 percent, 14.1 percent and 4.4 percent per year, respectively. And five-year Treasuries returned 4 percent, 6.1 percent and 6 percent per year, respectively.

And for the period 2003-2012, the HFRX index underperformed every single major stock and Treasury bond index, while exposing investors to far more risk.

What the SEC fails to understand is that having significant wealth doesn’t automatically qualify people as sophisticated investors. If it did, the hedge fund world would be a lot smaller.

Are you a well-funded institution seeking convoluted strategies to wring even more diversification from your multi-billion pound portfolio? An Ivy League fund manager, say, who gets the first phone call and discount rates on new funds?

You’re not? Then steer well clear of hedge funds. Or at least please don’t tell me I’m a silly thing for not understanding what I’m missing out on.

I already do my bit for charity. Hedge fund managers can fend for themselves.

From the money blogs

Book of the week: I haven’t read the relatively new Backstage Wall Street by Josh Brown yet, but it comes highly recommended. Half-price as I write.

Mainstream media money

  • Trade in key ETF poised to overtake trade in its companies – Bloomberg
  • Buffett, near 82, reflects on life in Omaha – Associated Press
  • Wooden skyscrapers – The Economist
  • Lessons from my ‘free’ cruise – CBS
  • Now is the perfect time to buy shares – Motley Fool
  • Retail investors know nothing – NY Mag
  • Download FSA’s new guide to RDR changes – FSA
  • 10 dangerous things you learn in business school – Forbes
  • Lump sum cash savers should seek bonuses – FT
  • Warnings over corporate bond funds [Cool data graphic]FT
  • FTSE 100 is five times more volatile than in 1990s – Telegraph
  • Ultra-cheap HSBC first-time buyer fixed rate mortgage – The Guardian
  • Why US companies may be set to payout cash en masseSmart Money
  • [A really dumb article comparing Apple and Facebook shares] – WSJ

Product of the week: NS&I has changed a few terms in its to-die-for index-linked certificates. Does it imply a new issue may be on the way someday?

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Further reading:

  1. Weekend reading: Did George Osborne just tell us to sell bonds?
  2. Weekend reading: Sell oil, buy drugs
  3. Hedge funds lag the simplest portfolios

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