Hedge Funds Let Down Their Well-to-do Investors in 2011

With the S&P 500 limping to a flat finish for 2011, you might feel like it was a wasted year for the market.

But as disappointing as a 0% return is, I have news for you. Things could be a lot worse.

You could have been invested in a hedge fund!

Hedge funds, elite investments available only to the super wealthy and capital-rich institutions like universities and pensions, make bold promises of generating extraordinary returns no matter what happens in the market.

Yet, the so-called "smart money" of the investing world failed to break even last year – and in some cases handed their investors crushing losses!

Hedge fund managers fumble the ball

Compared to the average performance of hedge fund managers in 2011, the self-directed investor who quietly contributed to a low-cost index fund all last year looks like a genius.

Which is surprising considering the incredible advantages hedge fund managers hold over individual investors.

They employ some of the best and brightest minds on Wall Street, including MIT mathematicians and Nobel-prize winning economists. And they trade at a rapid-fire pace, moving billions in and out of the market each day.  

But for all their predictive models and sophisticated trading strategies, most hedge fund managers were on the wrong side of the market in 2011.

According to the HFN Aggregate Index (which tracks the performance of more than 4,000 of these investment vehicles), hedge funds handed their investors an average loss of 5% for 2011. Even worse, hedge funds that focused solely on stocks lost an average of 7.2%.

2011 baffles even the best

Among those losers is the Advantage Plus fund managed by one of Wall Street’s most celebrated hedge fund managers, John Paulson.

Paulson famously racked up $3.5 billion by betting against subprime mortgages in 2007. And after another monumental year in 2010, he personally earned $5 billion -Wall Street’s biggest payday ever.  

But this year his funds tanked. In fact, Paulson’s largest hedge fund – Advantage Plus – lost a staggering 47%!

Dismal performances like these have forced many hedge funds to close up shop and give their frustrated investors their money back. In fact, as Bloomberg BusinessWeek reports, 213 hedge funds were liquidated last quarter alone.

Now contrast the poor performance of hedge funds with the 5.38% return the SPDR Dow Jones Industrial Average ETF (NYSE: DIA) handed its investors last year.

This index ETF bested Paulson and the majority of hedge fund managers in 2011 simply by tracking the 30 blue-chip stocks in the Dow.

Now I’m not advocating you buy an index fund and take a set-and-forget approach to your investing. It’s wise to remain vigilant – especially now in this turbulent market.

My point is you don’t need to have a billion dollars or pay exorbitant management fees to the likes of John Paulson to earn outsized returns. You can do it yourself.

The upside for individual investors

Last year, patient investors who stayed in the market and added to their positions when others fled stocks were handsomely rewarded with a late-year rally.

And although the market will face a fresh set of challenges in 2012 – the U.S. election, continued high unemployment around the globe, and slowing growth in Asia just to name a few – there’s enormous potential for growth. Even after the recent rally, stocks are dirt cheap compared to their return potential.

Price-to-earnings ratios remain at historic lows. And shares of some of America’s best run and most profitable companies are selling for bargain prices.

Now may be one of the best times to jump on high-performing, globally diversified companies before the big institutional money pours back into the market and inflates their share prices.

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Published by Wyatt Investment Research at