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Category: Commodities * Fooling Some of the People All of the Time
VisitFooling Some of the People All of the Time Popular Last Update: Apr/27/2014 15:36
Hedge funds and alternative investments have developed a kind of mythical reputation, so that many investors want to get into them. There are reasons to be skeptical:
* Are hedge fund managers really that much smarter than all the other smart investment professionals out there?
* Since risk adjusted returns are what count, is the risk properly reflected in the analysis?
* The heavy performance cost structures create a significant additional performance hurdle to overcome, so how do they do it?
* Can you tell beforehand which investments are superior and which are lemons?
* Can you count on the performance numbers supplied for a particular investment and for benchmarks?

Click the link above to download, from the Social Science Research Network, the research paper entitled: "Fooling Some of the People All of the Time: The Inefficient Performance and Persistence of Commodity Trading Advisors" by Geetesh Bhardwaj (SummerHaven Investment Management), Gary B. Gorton (Yale School of Management; National Bureau of Economic Research (NBER)) and K. Geert Rouwenhorst (Yale School of Management - International Center for Finance)

There are several dozen flavors of hedge fund investment strategies out there, and it is difficult to get any objective performance data on most of them. However, commodities futures trading is one of those areas where this is possible. This research paper is a real eye-opener in that it is able to divine the actual net performance that commodities traders actually delivered to their investors.

Bhardwaj, Gorton, and Rouwenhorst conclude that commodities futures investors put their investors' money at huge risk, while their investors net under 2% over T-bill returns on average. Many loose their shirts -- well, they loose a lot of their money. Obviously, there are numerous other investments that historically have netted far more than 2% over T-Bill returns with dramatically less risk.

The financial industry pitch for commodities is consistently related to lower asset class correlations when added to a portfolio, but what good is adding a highly volatile asset class to a portfolio, if incredibly excessive industry costs will siphon away the vast majority of asset returns? This is just more evidence of the pervasive financial industry disease of excessive and unjustified fees and costs, which bleed away large portions of the gross returns of investors -- leaving them with all the risk, but only some of the return.

Of course, one could argue that commodities futures are a unique subset of hedge funds, and are not representative of the wider set of hedge funds. Yet, I am still left with the nagging suspicion that they are more likely to typify the larger hedge fund space. All hedge fund performance data comes from the same privately collected and funded sources, reporting is voluntary, hedge funds can influence whether or not their superior (inferior) performance record is added to (removed from) the data set, old data is not available so the data set cannot be adjusted for survivorship bias, and the data is subject to other important biases that are discussed in this research paper. (Note that this is not the first research paper to question the quality and reliability of hedge fund performance data.)

If you do download and look at this paper, you do not have to read everything or immerse yourself in all of the data. The paper's introduction and conclusion will tell enough of the story. The research details just drive home the point that the financial industry makes a lot of money off OPM (other people's money).

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