Hedge funds still aren’t worth the money: Third time lucky?
Two weeks ago, I wrote the second part of my updates on hedge fund performance vs. conventional investment approaches. I concluded that the average hedge fund or a diversified portfolio of hedge funds still isn’t worth the money, but individual hedge funds can be an interesting investment. Just after the deadline, I saw a new paper from the University of Göttingen in Germany that took a fresh look at the same problem. Let's look at what they found in this third part of a series of two.
The research looked at 3,828 individual hedge funds with at least three years of track record from 2014 to 2024. The first analysis is straightforward and, at the same time, the most informative. What percentage of hedge funds manage to outperform the market either in nominal returns or on a risk-adjusted basis (i.e. Sharpe ratio)? ‘Market’ means a market-cap weighted index of all stocks traded on the New York Stock Exchange, American Stock Exchange, and Nasdaq.
Share of hedge funds outperforming the market
Source: Gehringer and Pauli (2025)
The chart is quite instructive. Just like traditional mutual funds, only a minority of hedge funds manage to beat the market either on nominal or risk-adjusted returns. And the longer the investment period, the smaller the number of hedge funds that manage to outperform. If you look at the ten years from 2014 to 2024, only 6.6% of hedge funds (one in 15 funds) managed to outperform the market in terms of nominal performance. And only 21% (one in 5 funds) outperformed in risk-adjusted terms.
What isn’t shown in the chart, however, is that those funds that outperform outperform a little more than those that underperform. So, if you invest in a well-diversified portfolio of funds, in the long run, you end up with the same Sharpe ratio as the market but lower nominal returns.
The authors claim that this result speaks for investing in a well-diversified portfolio of hedge funds, but why would I do that if the result is the same Sharpe ratio as the market but higher fees? No, this result shows that the only use of hedge funds is to invest in single hedge funds with specific desirable characteristics that can add a particular form of diversification to the portfolio. Well-diversified portfolios of hedge funds still don’t make sense to me.
Hedge funds are first and foremost designed to benefit the founders of the hedge fund, investors might benefit and equally they might not.
Fully agree, (most) hedge funds cost a lot and underperform a simple cheap ETF.
A GREAT example is RIT Capital Partners - a publicly-traded investment trust run by the mythological Rothschild family. Underperforms massively since 2022, it has a lot of private equity and hedge funds in it.
Theoretically it should be a copy of the Yale portfolio - giving you access to amazing funds like Mithril Capital, Millennium Partners, and more.
Practically it just costs you a lot of money in fees, and underperforms a simple cheap ETF.
Another hilarious example is Bill Ackman's fund- another publicly traded fund. I remember reading someplace that he has such high fees that just to beat a simple ETF he will need to make 30% PER ANNUM. No wonder he spends so much time on Twitter- you need a lot of marketing to sell such a overpriced product.