How Hedge Funds Keep Winning Clients Despite Prolonged Slump

The average hedge fund has returned 5.1 percent annually over the last 10 years, according to HFR, a hedge fund data firm.

The investment vehicle has even been outperformed by many “balanced” mutual funds. But the flow of clients to hedge funds isn’t slowing down, which begs the question: how do hedge funds keep winning clients when performance is so paltry?

Gregory Zuckerman dives into that question and comes up with some interesting answers:

How to explain the paradox of a superhot investment vehicle producing ice-cold returns for clients more smitten than ever?

Part of the reason for the lackluster returns: Hedge funds don’t have the same incentive to hit home runs they once did. They can charge management fees of close to 2% of assets. As the industry swells, many managers can get rich just keeping their funds afloat. A decent performance and no huge loss will do just fine.

The head of one of the world’s largest funds recently told me his challenge is to get his traders to embrace more risk, not less. Hedge-fund traders are more conservative because it’s in their self-interest to be more conservative.

There are similar ways to explain why hedge-fund clients aren’t up in arms. Some see an expensive market and want to be in a vehicle that should do better in a downturn.

But others simply want to keep their jobs. Recommending low-cost balanced mutual funds can be hard to justify if one has a well-paid job at a big pension fund or endowment. Properly allocating money to hedge funds is seen as a bigger challenge. Investing in brand-name hedge funds instead of big stocks once might have put an institutional investor’s career on thin ice. Today, avoiding popular hedge funds to wager on the market is seen as a risky career move.

Read more from his piece here.

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