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Brett Arends' ROI
May 17, 2011, 12:00 a.m. EDT
By Brett Arends, MarketWatch
LAS VEGAS (MarketWatch) "â? The rich and powerful of the hedge-fund world flew in here last week for a big confab.
Nearly 2,000 managers, investors, advisers and hangers-on took over the Bellagio for three days. George W. Bush stopped by. So did Colin Powell, TV historian Niall Ferguson, SAC billionaire Steve A. Cohen, and former British prime minister Gordon Brown.
Hedge funds don't offer the returns that you might think, according to Brett Arends, who has some ideas on alternatives. Interview by Stacey Delo.
I didn't make the poolside party on the first night, but it must have been quite an event. People looked pretty wobbly the next morning.
For all the big-name plenary sessions in the grand ballroom, the real action took place in side rooms, where investors and money managers talked dollars. Investors came in droves to meet new funds and try to find the manager who's going to make them rich.
I wish them luck. But as I mingled with the money mavens, I did some thinking.
Your typical fund manager takes 2% of your money off the top each year, just for showing up. Then he takes 20% of your profits "â? if any.
So your returns are going to be net of these costs. They're also net of any trading costs. To beat a basic index fund, a hedge fund has got to earn a lot more.
How much more? Do the math. According to data from the New York University's Stern school of business, over the past 80 or so years U.S. stocks have produced an average annualized return of 9.3%, and bonds 5%. So a portfolio of, say, two-thirds stocks, one-third bonds, would have earned an average return of about 7.9% a year.
Over an investment horizon of about 30 years, that's enough to turn an initial stake of $1,000 into $9,800.
But after 2%-and-20% fees, you'd only keep 4.7% a year (It would probably be even less, because profits are uneven, and in a down year the manager doesn't hand back 20% of the losses).
At that rate, you'd only finish with $4,000. In other words, the manager would have eaten two-thirds of your profits!
But that's not a fair comparison, say the fund managers, because we'll earn a higher investment return than the market.
OK, some will. But how much more?
If the market on its own earns 7.9% a year, a hedge fund with a 2%-and-20% fee structure has to earn 11.85%, gross, just to keep up.
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Brett Arends is an award-winning financial columnist with many years experience writing about markets, economics and personal finance in Europe and the U.S. He has received an individual award from the Society of American Business Editors and Writers for his financial writing, and was part of the Boston Herald team that won two others. He was educated at Cambridge and Oxford Universities, and has worked as an analyst at McKinsey & Co. He is a Chartered Financial Consultant (ChFC) and Accredited Asset Management Specialist (AAMS). His latest book, "Storm Proof Your Money,"? has just been published by John Wiley & Co.
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