These investments for the elite are opening to all - but think twice before saying yes

By Mark Hulbert

Hedge funds sound attractive - but on average they underperform even a basic 60/40 stock-bond portfolio

Hedge funds, private credit and other alternative assets have produced disappointing long-term returns.

For the first time ever, many investors will be able to allocate a portion of their retirement portfolio to so-called alternative investments, such as private equity, venture capital, private credit and hedge funds.

Think twice before jumping at that opportunity.

President Donald Trump issued an executive order last summer - "Democratizing Access to Alternative Assets for 401(k) Investors" - permitting defined-contribution retirement plans to include alternative assets in their suite of investments.

There's no denying the allure of alternative investments, given that the U.S. stock market faces a decade of possibly poor returns because of its currently extreme overvaluation. Eight prominent Wall Street firms are projecting that the U.S. stock market over the next 10 years will produce an annualized return that's less than half of its long-term average. In the popular imagination, at least, alternative investments will do significantly better.

There's no single performance benchmark for the entire alternative investment industry to which I can point. But the benchmarks that exist tell a discouraging story.

Take hedge funds, for example, which represent a major chunk of the alternative investment industry and have produced disappointing long-term returns. It's possible that alternative investments other than hedge funds have done significantly better, but this seems doubtful. Assets under management at global hedge funds have grown to $5 trillion at the end of this year's third quarter from $39 billion in 1990, according to data from HFR, which tracks the hedge-fund industry. Why would investors flock to hedge funds if other alternative investments were significantly better?

HFRI's Fund Weighted Composite index, which tracks the performance, of more than 1,400 single-manager hedge funds globally, has produced a 9.1% annualized return after fees from 1990 through the end of this year's third quarter. That's barely half the S&P 500's SPX 17.1% annualized return, including dividends, over the same period.

This comparison isn't entirely fair: the U.S. stock market has been far more volatile (risky) than the average hedge fund. Management fees also have a big impact on performance; an index-tracking S&P 500 fund costs far less to own than a hedge fund.

But HFRI's Fund Weighted Composite index even underperformed a balanced stock/bond portfolio (which allocated 60% to U.S. stocks and 40% to intermediate-term government bonds).

Beating the average?

Investors often take the attitude that the best hedge funds should do much better than the overall average. Yet choosing the best hedge fund requires being able to identify it in advance. If that ability did exist, we should see it in the performance of funds-of-hedge-funds - funds that invest in other hedge funds.

These funds-of-funds typically employ large staffs to rigorously analyze the track record of other hedge funds in hopes of identifying those with the greatest probability of producing impressive future returns. Yet, on average, funds-of-hedge-funds produce performance that is significantly worse than the average hedge fund.

This is evident in the chart below, which plots the cumulative returns since 1990 of HFRI's Fund Weighted Composite index vs. its Fund of [Hedge] Funds Composite Index. As you can see, the Weighted Composite index has performed far better.

The bottom line? We all hope to find a private-asset class that does significantly better than the public markets. But hope is not a strategy.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

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-Mark Hulbert

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