From Time: Much attention has been paid lately to Goldman Sachs’ decision to “help” average folks (ak.a. “the 99%” crowd) access the kind of high-stakes hedge funds once available only to the super rich (a.k.a. “the 1%”). And while all sorts of pundits and investor advocates have noted the folly of this and similar ideas, there’s a case to be made that the opposite is true—that average investors might do well by throwing some money Goldman’s way. In fact, there are two cases to be made. But first, let us stipulate that investing in this and most other hedge funds as they operate today is a really dumb idea—not just for regular Joes but for pretty much everybody else, too. Why?
1. Ridiculous Fees. Most hedge fund managers are paid by what is shorthanded as the “2-and-20″ model. That is, each year they earn a 2% asset management fee (vs. about 1.45% for the average mutual fund and 0.25% for index funds) plus 20% of any profits they produce. Given that, from 1998 through 2012, hedge fund managers earned $379 billion in fees while their investors earned only $70 billion in investing gains, a better shorthand for this fee structure would be the “There’s-a-sucker-born-every-minute” model.
2. Lousy Performance. Hedge funds of late—and for quite a while—haven’t performed especially well. In fact, they’ve underperformed the overall market. As Barry Ritholtz wrote for The Washington Post:
The latest performance data (via the HFRX Global Hedge Fund Index) reveal that hedge funds haven’t fared well at all: They returned a mere 3.5% in 2012, while the S&P 500-stock index gained 16%. Over the past five years, and the hedge fund index lost 13.6%, while the indices added 8.6%. That’s as of the end of 2012; it has only gotten worse in 2013. Most hedge funds have fallen even further behind their benchmarks this year, gaining 5.4% vs. the market’s rally of 15.4%. As a source of comparison, the average mutual fund is up 14.8%....