Wednesday, August 6, 2014

Do Hedge Funds And Private Equity Outperform The Market?

The efficient market hypothesis argues that knowledge is equally available to investors.  Therefore, it is difficult for investors to consistently provide a return that exceeds the market rate of return.  In other words, if we assume that markets are efficient, it is unlikely for an investor to consistently beat the market.  Of course hedge funds and private equity funds argue that they can beat the market.  They are able to earn large fees because sometimes they do place a winning bet that gets a lot of publicity.  A book was written about the billion dollar bet that John Paulson made against a mortgage backed security.  There has been less publicity about the failed bets that Paulson made which have reduced the equity in his fund by 50%.  Leverage works both ways.  Paulson won big on one highly leveraged bet and he lost big on others.  Hedge fund managers may accept the idea that the average return of hedge funds does not beat the market but they argue that they an exception to the average. This article makes an argument that is slightly different from the efficient market critique.  It reviews data which suggest another conclusion.  They may beat the market rate of return but they do not beat the market net of the fees that they charge.  Moreover, there is a lot of inconsistency in their returns.  Their is a high beta within hedge funds and private equity investments.  Investors in these funds must learn to live with inconsistent returns.

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