The Problem With Being Too Clever
For those of us who like the financial markets for what they are, it is difficult to find true alternatives. We all know the story about the equity markets in that they have gone up for a very long time. In fact, in the last 100 years, the Dow Jones Index (as one example of a market index) has gone up by an average of 8% per year. This is despite the great depression, two world wars, and various financial crises. There really is very little not to like about this performance, hence holding equities for the long term is one of the most widely acknowledged and accepted investment strategies.
In a world where an investor can get exposure to this wonderful performance for next to nothing (Fidelity recently announced that they would be offering equity indices for zero costs), it really never seizes to amaze me why everyone is so obsessed with beating the market? Avid readers of our blog know my dislike for active management and seriously, why would anyone pay anyone else, or even spend one minute thinking about, trying to beat the market when the risk of any such strategy (stock picking et al) is exactly the same. After all, when there is an adverse market event, the active strategies will go down just as much as the index will. And even if they don’t quite, do you really care if you are down 49% when the market is down 50%?
Enough said, but then there are the hybrid strategies, and these are the ones that really deserve our disdain. You see, some very clever people figured out some four decades ago, that you can create an entirely different strategy by playing the other side of the market. In other words, if they like one stock, say BMW, but hate Daimler, then you could just buy one and sell the other. You would get rewarded if you are right and BMW outperforms Daimler, but without having to fear a market crash (because you have a market neutral position). Fantastic, and a whole new industry emerged, and they placed their strategies in fancy new vehicles called “hedge funds”. People started playing all kinds of things versus each other. Sometimes it worked, sometimes it didn’t, but the important point is, that such strategies are clearly different and hence an alternative to just being exposed to the market outright. Great.
But then of course, people got really clever, because unlike the market index you buy from Fidelity for nothing, hedge funds can charge 2% management fees and 20% performance fees. And since markets tend to go up, why not just take advantage of that and get a bit of exposure to that, whilst charging the very high fees? Low and behold, more than 95% of so called long / short hedge fund strategies are actually anything but market neutral. The arguments I get are very colourful, from “why not get exposure to a good thing”, “you are paying us for the stock picking”, or “we have a market view”. All fine, but I ain’t paying you as much as 3.6% (2% + 20% * 8%) for the markets to go up.
So, in the interest of clearing up this argument once and for all, and saving the world from spending billions of hard earned cash for absolutely nothing, the markets are fine, you don’t need to beat them. And for heaven’s sake, please avoid anything that isn’t absolutely market neutral when you choose your alternative strategies. It’s a scam, it’s immoral, it’s an absolute disgrace and the only way to avoid over paying for something when you really don’t have to, is to just say “no”.