Why long-term investors are ahead of hedge funds

Years ago, Jeff Bezos was asked the best advice he got from Warren Buffett. Bezos remembers asking the legendary investor, “Your investment thesis is so simple. Why aren’t more people copying you?”

Buffett’s response was emblematic of the philosophy that has earned him billions: “Nobody wants to get rich slow.” His point bears repeating for the sophisticated investor and the beginner. And there’s a powerful lesson we can distill: while organizations like hedge funds have enormous resources, you can outrun them with a buy-and-hold approach. A long-term view – remember Buffett’s quotes, please! — combined with patience and smart decisions, it can generate good returns for your portfolio.

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Of course, Bezos knows something about that. His long-term commitment is evidenced in his letter to Amazon shareholders from 1997, when the company went public. He encouraged investors to zoom out and understand the benefits and approaches of long-term thinking.

As for Buffett, almost all of his gains came after he turned 65, a classic example of the power of compound interest over long periods of time. The phrase “time in the market beats the beat of the market” might be truer today than ever.

It’s a general fact: time in the market is often better than market timing strategies. And it’s certainly a better approach for the average retail investor than many strategies deployed by large hedge funds. In fact, most hedge funds actually try to extract all possible gains through short positions and market-timing strategies, as well as short-term trades.

less is more

Consider: Most hedge funds have large teams and trade regularly, but most underperform the S&P 500 over time. Although the annual differences are only a few percentage points, they have a significant long-term impact.

According to data from the Barclay Hedge Fund and NYU Stern School indices, for example, the average hedge fund gained 10.29% in 2020. The S&P 500 gained 18.40% that year. . The difference was even starker in 2019, when hedge funds averaged a 10.67% gain. The sp? A stellar 31.49%.

From 2011 to 2020, the S&P 500 has beaten the average hedge fund every year.

Year Average return of hedge funds Average return of the S&P 500 index
2011 -5.48% 2.10%
2012 8.25% 15.89%
2013 11.12% 32.15%
2014 2.88% 13.52%
2015 0.04% 1.38%
2016 6.09% 11.77%
2017 10.79% 21.61%
2018 -5.09% -4.23%
2019 10.67% 31.49%
2020 10.29% 18.40%

Data source: Barclay Hedge Fund Indices and NYU Stern School

A simpler, longer-term investment process helps retail investors avoid market-timing and short-term trading. Emotions can get in the way. In addition, the markets unexpectedly fall. It is impossible to accurately predict market ups and downs, which means that almost all investors benefit from long-term buy and hold strategies. Although it sounds simple, not everyone follows this approach. It can be tempting to chase excess returns out of the market through market timing strategies.

Unsurprisingly, these efforts are mostly in vain. Wealthy hedge fund managers manage billions of dollars. Yet most studies show that investing in the S&P 500 Index, one of the simplest index funds, returns more than 90% of hedge funds over the long term. Not to mention that hedge funds charge fees to manage the money.

According to Hedge Fund Research, hedge funds charged an average of 1.4% management fees, as well as a performance fee of 16.4%. The performance fee is often the main source of income for hedge funds. But by avoiding their philosophy and thinking longer term, you can outperform them without the burden of additional fees. Chances are these fees will add up over time and affect your returns. Investing alone does not involve any commission, fees or even minimum investment.

The future is uncertain, but the trend should continue

There doesn’t seem to be an end in sight to the trend. Research from Vanderbilt University’s Owen Graduate School of Management found that hedge fund performance will continue to track the market as a whole.

“Hedge funds have generally underperformed, but even selecting a subset of funds using performance prediction models wouldn’t have helped you,” Nick Bollen, Frank K. Houston Professor of Finance at the Vanderbilt’s Owen Graduate School of Management and co-author of the paper, noted.

Bollen added: “The distortions created by central banks and the impact of regulation are long lasting, so it is reasonable to expect that hedge fund performance will continue to lag behind their success. prior to mid-90s to mid-2000s.”

Similarly, in his 2016 letter to shareholders, Buffett wrote, “Investors, on average and over time, will do better with a low-cost index fund than with a group of funds-of-funds.”

There are no significant annual fees, performance fees and active trading fees when you play the game long term as a retail investor. This can go against human psychology and the need for more money and bigger returns sooner. It also requires patience. But it can be quite lucrative, and the approach can be a powerful tool in arming long-term investors for healthy gains.

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