Hedge funds are notorious market underperformers — a fact bandied about seemingly every couple months, via survey, study or story. The latest bit of news isn’t any different.
According to Goldman Sachs (NYSE:GS) research, the hedge fund industry is continuing its dry spell. The average return among 699 hedge funds (aggregating $1.2 trillion in assets) is 4.6% year-to-date, and only 11% beat the S&P 500!
Anyone with money in a hedge fund wouldn’t be blamed for being fed up and pulling their cash. But should they — and if so, where should they go?
Despite the galling statistics, the fact remains that some of the world’s top investors are hedge fund operators. They generally can beat the averages because they have the advantage of flexibility. That is, a hedge fund can invest in different types of strategies — like going short or engaging in arbitrage — and get exposure to diverse investments like interest rate futures, commodities and currencies.
Of course, the hedge funds themselves aren’t really the worry of mom-and-pop investors. After all, these funds are mostly for wealthy people and institutions, thanks to steep investment requirements that can hit seven digits.
Still, the average Joe should pay some attention. In the past few years, a variety of hedge funds have come to market in the form of mutual funds and even exchange-traded funds.
For instance, the IQ Hedge Macro Tracker (NYSE:MCRO) tracks strategies focused on macro bets as well as investments in emerging markets, but 4.5% year-to-date returns are less than half the gains of the broader market. There’s also the Marketfield Fund (MUTF:MFLDX), which takes a long/short approach to the markets and has gained a more respectable 10.6%.
And some funds — such as the Global X Top Guru Holdings Index ETF (NYSE:GURU) and AlphaClone Alternative Alpha ETF (NYSE:ALFA) — even play the holdings of multiple hedge funds.
Despite all this, it’s too early to get a true sense of their value. According to Morningstar, the average return for long/short funds came to 3.22% for 2012, with fees averaging a hefty 2% — much better than a traditional hedge fund, where the fund manager traditionally gets a 2% management fee and 20% to 25% of the profits, but it’s still 2% coming out of your returns on average. Most investors’ money would be better off elsewhere.
Index funds remain a better alternative, whether it’s for individual investors who don’t have the time to pick stocks or participate in top hedge funds, or even the high-rollers who are done making a relatively riskier gamble on their large sums.
There are index funds for a myriad of categories, such as emerging markets, junk bonds, commodities and so on. But considering the struggles hedge funds have in beating the market, maybe one of the best strategies you can adopt is playing … well, the market.
Mutual fund investors could consider the Vanguard 500 Index Investors Fund (MUTF:VFINX), which tracks the S&P 500 and its stable of blue-chips like Apple (NASDAQ:AAPL), IBM (NYSE:IBM) and General Electric (NYSE:GE) for a low, low 0.17% in fees with just a $3,000 minimum investment. VFINX even yields a Treasury-beating 1.8%.
On the ETF side, the gold standard is the SPDR S&P 500 ETF (NYSE:SPY), which similarly tracks the S&P 500 for a lower expense ratio of 0.09% while offering a slightly better yield of 1.9%. Both funds have gained 13% year-to-date, just like the S&P 500.
The returns of VFINX and the SPY naturally won’t yield you market-crushing returns, since they’re tracking the market, but if you believe in the long-term growth of the U.S. stock market, there’s few surer places to put your money.
Not to mention, 13% returns this year would make most hedge fund managers green with envy.
Tom Taulli runs the InvestorPlace blog IPOPlaybook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli. As of this writing, he did not own a position in any of the aforementioned securities.